DISCUSSION PAPER

South Africa

The Business Environment for IndustrialSmall and Medium Enterprises

Brian Levy

THE WORLD BANK INFORMAL DISCUSSION PAPERSSOUTHERN AFRICA ON ASPECTS OF THEDEPARTMENT ECONOMY OF SOUTH AFRICA

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PREVIOUS WORLD BANK PAPERS ON SOUTH AFRICA

Previously published in the World Bank series of informal discussion papers on SouthAfrica:

Levy, B. January 1992. "How Can South African Manufacturing Efficiently CreateEmployment? An Analysis of the Impact of Trade and Industrial Policy".

Kahn, B., Abdel, S. and Walton, M. May 1992. "South Africa: Macroeconomic Issuesfor the Transition".

Fallon, P. October 1992. "An Analysis of Employment and Wage Behavior in SouthAfrica".

Southern Africa Department, May 1993. "An Economic Perspective of South Africa".

Belli, P., Finger, F., Ballivian A., August 1993. "South Africa: A Review of TradePolicies".

Riley, T., November 1993. "Characteristics of and Constraints Facing Black Businessesin South Africa: Survey Results".

Southern Africa Department, February 1994. "South African Agriculture: Structure,Performance and Options for the Future".

Fallon, P., Pereira da Silva, L., April 1994. "South Africa: Economic Performance andPolicies".

Southern Africa Department, April 1994. "South Africa: Financing the MetropolitanAreas of South Africa".

Southern Africa Department, June 1994. "Reducing Poverty in South Africa".

Southern Africa Department, December 1995. "South Africa: Natural Resource Issuesin Environmental Policy".

Southern Africa Department, December 1995. "South Africa: Education SectorStrategic Issues and Policy Options".

In addition, a number of technical and seminar papers prepared by World Bank staffand South African counterparts in key sectors have been discussed in the country.

FOREWORD

To resolve South Africa's pressing unemployment problems, the country urgently needsto move towards a more labor-demanding pattern of growth. Consequently, an ambitiousprogram of industrial reform is now underway-- including tariff reforms, a progressiverelaxation of exchange controls, a systematic drive to promote small, micro and mediumenterprises, initiatives to upgrade labor skills, and a heightened emphasis on fosteringtechnological and organizational development within firms. Since 1991, the World Bank hassupported these efforts -- working collaboratively with South Africans on a series of informalstudies, and arranging for international experts to participate in the formulation of new policiesand programs.

One lesson from World Bank economic work worldwide is that, as a way of ensuringthat the targets for industrial reform are broadly consistent with realities on the ground, it ishelpful to "take the pulse" of private firms. This can be done by using an approach along thelines of the collaborative effort by a team of World Bank and South African researchersdescribed in the present paper

The research builds on methodologies for private sector assessment used by the WorldBank in over two dozen countries, and the results are consistent with two recurrent themes fromprivate sector assessments the world over. First, the perceptions and experiences of entrepreneurssometimes can be significantly different from the "received wisdom" of policymakers, withimportant implications as to the priorities for reform. Second, the business environment iscontinually evolving: constraints which appeared most pressing in late 1993 (the time of thesurveys) can rapidly give way to a very different set of problems. In an environment evolving asrapidly as South Africa's, it can thus be useful to probe the perceptions of enterprises every fewyears, as a benchmark for evaluating the impact of a given set of reform priorities.

Southern African DepartmentThe World BankFebruary 1996

Copyright 1996The World Bank1818 "H"Street, N.W.Washington, D.C. 20433, U.S.A.

This is an informal study by [Yorld Bank staff and contributing South Africans, publishedfor discussion purposes.This is not an official IYorld Bank document.

ACKNOWLEDGMENTS

This paper was prepared by Brian Levy, drawing on inputs from a team including Izak Atiyas andYvonne Tsikata (World Bank), and Frederick C. v N Fourie, Anton Grutter, Claudia Manning andMoss Ngoasheng (South African consultants). Reviewers at the World Bank who provided helpfulcomments include Ataman Aksoy, Gene Tidrick, Luis Pereira Da Silva (AFI), William Steel(AFTPS), Andrew Stone (PSD) and Paul Holden (LAT). The views expressed in the paper areentirely those of the lead author, and should not be attributed to the local consultants or the WorldBank.

TABLE OF CONTENTS

1. THE ISSUES ------------------------------

11. SOUTH AFRICA'S SMEs: SAMPLE SELECTION AND ENTERPRISE PERFORMANCE -------- 311.1: Sample characteristics -------------------------------------------------------------------------------------- 3

Sample design. --------------------------------------------------------------- a---- -------------- -- 3Dualism.---------------------------------Patterns of enterprise growth.. -------------------------------------------------------------------------------- 5Export performance.-------------------------------------------------------------------------------------------- 8An overview of sample performance.------------------------------------------------------------------------ 9

III: CONSTRAINTS ON SME PERFORMANCE: AN OVERVIEW---------------------------------------10Access to finanice .---------------------------------------------------------------------------------------------- I IHuman resource constraints. --------------------------------------------------------------------------------- 13Regulatory and industrial relations constraints.------------------------------------------------------------14

IV: INDUSTRY STRUCTURE. COMPETITIVE CONDUCT AND SME PERFORMANCE ----------15IV. 1: The Setting-------------------------------------------------------------------------------------------------- 15IV.2: The Analytical Framework ------------------------------------------------------------------------------- i6

Strategic factors.-----------------------------------------------------------------------------------------------17Enterprise-specific factors.-----------------------------------------------------------------------------------18Entrepreneur-specific factors.--------------------------------------------------------------------------------19

IV.3: The Main Results ------------------------------------------------------------------------- -- 19Product markets.-----------------------------------------------------------------------------------------------20Input Markets:--------------------------------------------------------------------------------------------------22

V. SOME IMPLICATIONS --------------------------------------------------------------------------------------- 24Competition policy. -------------------------------------------------------------------------------------------26Access to finance.----------------------------------------------------------------------------------------------26Import and export competition.------------------------------------------------------------------------------27Technical and marketing support. --------------------------------------------------------------------------- 27Uncertainty and industrial relations. ------------------------------------------------------------------------28

The Buisiniess e few S -I/ri'L .'. ' Oslrh '. '

The Business Environment For South Africa's Industirial SmallAnd Medium Enterprises

I. THE ISSUES

For South Africa to successfully meet the daultitg challeniges of its post-apatheid eta.the trajectory of industrial developmenit will need to change. The problemii is nlot snimpl\ oic o .a

slow rate of growth. At least as important. the pattern of growth has resulted in poorproductivity performance and virtually no employmenit creationi. In additioni, the oxvhr\cllre nnq:bulk of industrial activity is undertaken by white-owined enterprises. As Southi Af'rica encro,esfrom the apartheid era, it is important that there be enilaniced opportunities for bLsISel.sparticipation by historically excluded segimenits of society. A new trajector\ of industrialdevelopment which can yield sustained increases in employment and produictivity. Increa..edoutput and investment, and broader-based participation is called for.

Over the past three years, the outline of an industrial strategy whichi has the potential toachieve these objectives has come into view. One key element of that strategY is to sireiigthienthe export and domestic competitiveness of downstream, light manufacturing -- especiallproducers of higher quality, differentiated products. with significanit desig,n1 colitent. ortechnological complexity, or with quick market turn-around.

Table 1: Distribution Of Manufacturing E:mployment ByEstablishment Size. Cross-Countrv Comparison

ESTABLISH- NUMBER OFMENT SIZE ESTABLISHI- DISTRIBUTION OF EMPLOYMENT(Number of [ MENTSiEmployees) l

N incSouth Africa South Africa Singapore Korea Countrx

(1988) (1983) 1198I ) A cr:tge

5-19 7718 5.0% 28.6% 103% 113.20-99 6448 18.9% 26.5 IX 5

100 or More 3208 76.1 71.4 62 8 64 6Total% 100.0 100.0TOTAL. 17.374 (1,520.886)

(Number)

Sources: CCS. 1988: Berrv and Mazundar ( 1993) Biggs and Snodgrass (1992)

The world over, SMEs play a disproportionately large role in lig,ht maniufacturillt,especially of differentiated products, and a similar pattern prevails in South Africa. Yet asTable I shows, relative to international norms, small and medium establishmenits aie undee-represented in South African manufacturing. As of 1988 South Africa had 17,374 manUftihCtUrihtta

establishments with five or more workers. There were 516 establishmcnts wilth 0() or imorc

Paue l

The Buisiness Environment fbr Souiith Africa s Industrial SNIEs

workers, and these accouLited for 49 percent of manufacturing value added. The share ofmanufacturing employment in establishimienits of 100 or more wvorkers was higher in South Africathan in Korea, Singapore (both of wlhich generally are viewed as being oriented towards largefirms), Malaysia, or the average for a group of ninie countries with per capita incomes in the$2,000 - $5,000 range.' Moreover, the data In T able I uliderestimilate the dominianice of largebusiness, since (as examined furthier in section 111) an un1usually high fraction of South Africa'sprivate sector is controlled by tour giant busilless conglomerates. Along with their corebusinesses (typically in mining and heavy industry) these conglomerates also have controllinginterests in a very large number, and wide variety, of uLirelated businiess activities. A larger rolefor SMEs is called for if the industrial strategy outlined earlier is to be successful.

This study draws on the results of a survev of 165 firms conducted in August, 19932 toexplore to what extent South Africa's SMEs (that is, independenitly-owned firms with fewer than300 employees) have the potential to participate centrally in a labor-demanding industrialstrategy built around exports of light manufactures. It probes what are the constraints to SMEparticipation, and how these might be relieved.

The results suggest that SMEs should not be viewed as a panacea for thle ills of SouthAfrica's industrial performance. As noted in Table 1, for deep-seated economic and apartheid-related political reasons, SMEs comprise an unusually small share of South Africanmanufacturing, limiting their potential impact in the immediate future. Further, as in countriesthe world over, the results show that South Africa's most successful SMEs generally are run byhighly educated and experienced entrepreneurs. Given the country's hiistory of dualism anddiscrimination, it follows that in the near future strong manufacturing SMEs are unlikely toemerge in substantial numbers from historically disadvantaged segments of the population(though changes in services may be more rapid).

The results also suggest that there are limits in the extent to which policy interventionscan rapidly accelerate SME participation. It is often asserted (virtually as a corollary of SouthAfrica's high levels of industrial and conglomerate concentration) that South Africa's businessenvironiment is systematically biased against SMEs. In a setting where the economicenvironiment is substantially biased towards large firms, there are three areas in which policy andprogram interventions could hold the potential of rapidly enlarging the historically limited roleof SMEs. Such interventions could enhance SME access to finance; they could ease regulatoryinhibitions of SME performance; and they could relax or remove anti-competitive behavior onthe part of large firms. Yet, surprisingly given the conventional wisdom, the firm surveysuncovered little evidence that manufacturing SMEs perceive the constraints associated withfinance, regulation or industrial organization to be especially binding. As argued later in theconclusion to this paper, new policy and program interventions in these areas are indeeddesirable. However, their positive impact on the overall trajectory of industrial development islikely to be limited, at least in the short-to-medium term.

IThe bias towards large tirms would have appeared even greater ifthe share of employment in establishments with 0-4 workerswere included. This group is excluded since the South African data appears to substantially underestimate the number ofestablishments in that category.

2Along with the August, 1993 survey. the discussion incorporates some results from an earlier (April, 1991) survey of 51 SMEgarment firms.

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The Business Environmentfor South Africa's Industrial SMEs

To be sure, there are limits as to what field surveys can reveal as to the potential ofSMEs. In particular, field surveys of necessity focus on existing firms rather than those whichwere even discouraged from entering. While it is nonetheless true that surveys of existing firmscan offer useful insights into the business environment confronting SME entrants, there is awide variety of additional influences on individual decisions as to whether to start-up a newbusiness. It is entirely plausible that South Africa's recent political transformation will propel asignificant number of educated and experienced South Africans to alter their career choices infavor of starting up a new business rather than to seek employment in large-scale privatecompanies or in the public sector. Even so, at the very least, the empirical results suggests that,in addition to SMEs, South Africa's policymakers will need to look to other private actors -- tocompanies quoted on the Johannesburg Stock Exchange, to foreign investors -- as key moverstowards an efficient, outward-oriented and labor-demanding path of industrial development.

II. SOUTH AFRICA'S SMES: SAMPLE SELECTION AND ENTERPRISEPERFORMANCE

11.1: Sample characteristics

Sample design.

The August 1993 sample of 165 SMEs was selected from six subsectors ofmanufacturing:

* automotive components (26 firms)* footwear (43 firms)* furniture (35 firms)* garments (10 firms, plus 51 firms in April, 1991)* metal household fixtures (27 firms) and* plastic products (24 firms)

The sample was drawn from specific subsectors, rather than randomly across manufacturing,because one of the research goals was to learn about the competitive environment (e.g. ease ofentry, and vulnerability to monopolistic practices) confronting South Africa's SMEs and oneuseful approach to learning about this environment is to examine the industrial organization ofinput and output markets for specific products. In all subsectors, the costs of initial entry arerelatively low, so firms have the opportunity to start small and subsequently to expandincrementally.

Though limitations in available information made it impossible to follow strictprocedures of stratified sample selection, an effort was made to focus the field work on fourtypes of firms. First, the field work focused disproportionately on established firms whichemployed 10-299 employees as of the time of the survey. 135 of the 165 firms sampled fell intothis size category; 22 firms had fewer than 10 employees, while 8 had 300 or more. Second, itfocused disproportionately on independently-owned establishment; 141 of the firms were heldprivately, and 20 were group-owned. Further, the sample was selected to incorporate rapidly-growing, potentially export-oriented SMEs, and SMEs with Indian, Coloured or African

Page 3

The Business Environment for South Africa 's Industrial SMEs

entrepreneurs. The relative importance of these two groups varied across subsectors, with surveyselection in the automobile components and plastic products skewed towards growing, export-oriented entrepreneurs, and the metal fixtures and garments survey skewed towardsentrepreneurs other than white; the footwear and furniture surveys incorporated both groups ofSMEs in their samples. (The earlier survey of garments also targeted entrepreneurs other thanwhite.) A corollary of these patterns of selection is that relative to the aggregate SMEpopulation, established, non-dynamic, white-owned SMEs (which comprise the bulk of SouthAfrica's manufacturing SMEs) are under-represented in all subsectors.

Dualisn.

Table 2 confirms Table 2: Firn Size And The Ethnic Background Of Entrepreneursa pattern which is hardly

supiiggiven South FIRM SIZElsurprising (Number of Employees)Africa's history -- namelythat there is a strong Ethnic Background 04 5-19 2049 50- 100+ TOTAL

correlation between the 2 l28White 2___ 9_2_2_3_8

size of an enterprise and Indian 2 8 23 6 14 41the racial background of Coloured 1 4 1 I 1 8its entrepreneur: 62 African 7 4 0 0 0 IIpercent of SMEs run by TOTAL 12 25 35 31 46 149

white owner-managers --- but only 37 percent of the remainder -- have 50 employees.Determined efforts were made to identify African proprietors of manufacturing SMEs that werelarger than microenterprises. Even so, not one of the 30 African SMEs identified' had twenty ormore employees. (There is , of course, a substantial number of larger scale African-ownedbusinesses in the services sector.) The imbalance between racial background and SME size isless stark for entrepreneurs of Indian background. Certainly, relative to their proportions of thepopulation, these entrepreneurs are under-represented in the sample -- despite the effort tosample disproportionately SMEs owned by historically disadvantaged segments of society. Yetwithin the sample of Indian or mixed-race owned SMEs, the size distribution was reasonablybalanced, with more than half of this group of firms employing twenty or more people.

In part, these racial imbalances in the size distribution of SMEs can be accounted for byvariations in the level of education, which international experience shows to be an importantdeterminant of enterprise performance.4 Racial discrimination during the apartheid years led tosubstantially greater opportunities for education for white South African relative to their Indian,mixed-race, and especially African counterparts. As Table 3 shows, there is a strong correlationbetween the average size of firms and the years of education of the entrepreneur, both for thesample as a whole, and (as the breakdown for white entrepreneurs suggests) within individualracial categories.

31 1 in the 1993 SME survey, and 19 in the 1991 garments survey.

4For example. in recent studies of successful SME exporters in Indonesia. Korea and Colombia; for an overview, see Brian Levy,"Successful SMEs and their Technical and Marketing Support Systems: A Comparative Analysis," World Bank, Policy ResearchWorking Paper, number 1400, October. 1994.

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The Business Environment for South Africa 's Industrial SMEs

Table 3: Firm Size, Ethnic Background And YearsOf Education (Number of Firms)

Years of Education SIZE(Number of Employees)

________________________ _______0-4 5-19 20-49 50-99 100+ ALLAll Firms0-1 I Years 8 6 0 0 0 14

12-15 4 8 14 14 17 5716+ 0 5 15 15 24 59

White .0-l I Years - I _ _ _ -_ ______l

12-15 2 4 l I I __9 3716+ 2 12 19 1 44

African l l l f l l

0-1 IYears 6 3 9 T 1 : T 1 9

i 2-15 1 - __ _ _ _ _ 1116+ 4 - I I

Yet it is likely that unequal access to education (and to opportunities for businessexperience) accounts for only part of the racial variations in the size distribution of firms. Alsopotentially relevant are unequal access to wealth, to loan finance, and to input and outputmarkets, potentially in part a legacy of past discrimination, and in part a symptom of continuingdiscrimination. The role of some of these variables will be considered later in this paper.

Another noteworthy racial imbalance is the correlation between the racial background ofentrepreneurs' and enterprise age. Forty nine percent of the white-owned firms in the sample --but only 9 percent, 25 percent and 33 percent respectively of African, coloured and Indian-owned entrepreneurs -- have been active for twenty or more years. Viewed from oneperspective, these variations provide a welcome signal that the progressive demise of apartheidhas given increased opportunities to entrepreneurs other than white. But viewed from anotherperspective, the date could be interpreted as pointing to a startling collapse of manufacturingstart-ups in recent years by white entrepreneurs (although the possibility cannot be ruled out thatthe result is an artifact of how the sample was selected).

Patterns of enterprise growth.

For the three years prior to the survey, South Africa's economy had been passing throughits deepest recession in over fifty years. The sample SMEs hardly were immune to these difficulteconomic conditions. From 1991 to 1993, employment levels declined in 65 of the 115 firmswhich provided information, with 31 firms experiencing an employment decline in excess of 25percent.

Table 4: Changes In Enterprise Size-Start-Up To CurrentThis bleak short-term picture (Number Of Firms)

disguises rather more robust NNmbers CfRFinsZl Numbers CURRENT SIZE. l

expansion of employment over the Employed Numbers Employed

lifetime of the SMEs surveyed. As Start-Up Size 0-10 20-49 50-99 I 100+ Total

Table 4 shows, 71 percent of the l-5 28 15 13 8 64

sample firms started-up their 6-10 4 14 7 _ 10 35I l

operations with 10 or fewer than 10 30-50 - 2 2 II 15

people. The data in Table 4 take no 51 or More - I 3 5 9TOTAL 33 34 32 39 138

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The Business Environment for South Africa 's Industrial SMEs

account of the life-spans of the sample enterprises, and so canlot be used to evaluate the rapidityof enterprise growth. To use the sample as a basis for evaluating the growth performance andpotential of South Africa's SMEs, it is useful to distinguish among three distinct elements:

* First, international experience shows that young, small firms grow most rapidly, withgrowth slowing as enterprise matures. Consequently, tihe speed (or slowness) of enterprisegrowth needs to be evaluated within specific age cohorts.

* Second, attention should be paid to the variance among rates of SMEs growth withinindividual age cohorts, insofar as unusually rapidly-growing "outliers" can be important pioneerswho demonstrate what is plausible, and thereby shape the development of the SME sector morebroadly.

* Third, insofar as growth rate varies with age, the overall growth impact of the SMEsector as a whole depends importantly on the age distribution of firms.

The first rowof Table 5 shows the Table 5: Segmentation Of Sample By Enterprise Performanceaverage annual AGE (Years)

employment growthrate of the median firm 0-4 5-9 10-14 15-19 20or

within each age l I More ALLwithin each age ~~~~~~~~~A: Categorization Criteriacategory. As expected, Median Average

this median growth Annual

rate declines Employment 55% 26% 21% 11% 5-8%Growth Rate ____ ______

monotonically with Minimum Size forage. Perhaps 'High Flyer"

unexpectedly given the (Number of 20 40 60 75 100 or

prevailing view that Employees) I I I I i MoreB. Performance Segment (Number of Firms)South Africa's business High Flyer 7 7 8 3 4 29

environment has long Promising 4 5 2 0 0 II

been tilted against Rump 7 4 9 1 25 55Backwater 5 10 6 5 13 39

SMEs, once age IS TOTAL 23 26 25 19 42 134

controlled for, averagelifetime growth amongthe sample SMEs appears to be quite rapid.

It is in the age distribution of firms and the patterns of variance in enterpriseperformance within age categories, that the roots of the apparently problematic performance ofSMEs can be found. As the bottom row of Table 5 shows, fully 64 percent of the 134 firms thatprovided information were at least ten years old. By contrast, only 25 percent of a recent sampleof successful Indonesian SMEs were in this "mature" category. This apparent low rate of newSME entrants into South African manufacturing slows down the aggregate growth rate andcomplicates the challenge of enhancing the dynamism of SMEs.

To examine further the growth patterns among sample SMEs, the firms can usefully begrouped into four distinct categories:

Page 6

The Business Environment for South Africa's Industrial SMEs

* "High Flyers", incorporating SMEs which have grown over their lifetime by at least the mediangrowth rate for their age category, have had no job loss over the past two years, and are larger than theminimum size specified for their age category in Table 5.

* "Promising SMEs", incorporating firms which have been in business for less than 15 years,have grown by at least the median growth rate for their age category, and have had no job loss over the pasttwo years, but nonetheless (as a result of unusually small start-up size) fall below the minimum sizespecified in Table 5 for high-flyers.

* "Backwater" SMEs -- those whose growth rates have been less than two-thirds of the medianrate for their age category. And

* "Rump" SMEs -- the remainder of the sample.

As Table 5 shows, 29 of the sample firms are "high-flyers", and a further 11 are "promisingSMEs"; 39 are "backwater" firms, leaving 55 as the "rump" of the sample.

A disaggregation within the "high-flyer" segment highlights two further challengesconfronting an industrial strategy which aims to secure substantial employment expansionthrough SME development. First, as Table 5 shows, disaggregation by age shows that (evenusing an age-adjusted median growth benchmark) the "high-flyers" are concentrateddisproportionately among younger firms: "high-flyers" comprise 30 percent of sample SMEs thathave been in business for under 15 years, but only 13 percent of their older counterparts.5 Insofaras South Africa's SMEs are skewed toward older firms, and insofar as the older firms tend to belarger, the recent underperformance of older firms complicates the challenge of employmentcreation.

Second, even the "high-flyers" generally do not fly all that high. In rapidly-growingdeveloping countries it is not at all uncommon to come upon SMEs that have grown forsustained periods at exceptionally rapid rates transforming within the space of a decade a, say,1 0-person start up operation into a firm with over 500 employees. By contrast, as of the time ofthe survey 18 of the sample's 29 "high-flyers" had fewer than 100 employees. Only the 12enterprises highlighted in Table 6 have been notably successful in rapidly generatingemployment on a sustained basis.

Table 6: Twelve Super "High-Flyers"

_ _ _ _ I _ _ I _ _ I [~~~~~~~~~Annual] _

Age Start-up Size Current Size Employment Sectorl ~~~~~~~~~~~~~~~~~Growth Rate

Enterprise A 33 2 390 17.4% FumitureEnterprise B 31 3 180 14.1% Auto PartsEnterprise C 20 10 275 18.0% FootwearEnterprise D 18 7 125 17.4% FurnitureEnterprise E 10 I 100 58.5% PlasticsEnterprise F 10 6 150 38.0% PlasticsEnterprise G I 27 600 32.6% FumitureEnterprise H 13 4 130 30.7% Auto PartsEnterprise I 6 2 60 76.3% PlasticsEnterprise J 5 8 85 60.4% PlasticsEnterprise K 13 5 103 26.2% PlasticsEnterprise L 13 10 200 25.9% Clothing

This uneven distribution reflects the disproportionately large share ofjob losses over the past two years among older firms.

Page 7

The Business Environment for South Africa 's Industrial SMEs

Export performance.

Until very recently, South Africa's economic environment hardly was a propitious onefor exporting. Prior to the 1 980s, the focus of industrial policy was virtually entirely on importsubstitution. In the 1980s, policy shifted in a more outward-oriented direction. Protection policybegan to be reformed, and various incentives for exports were introduced -- with the 1991General Export Incentives Scheme (GEIS) the most recent. However, at the same time asdecision-makers domestically began to recognize the importance of internationalcompetitiveness, sanctions associated with global opposition to apartheid created a new set ofobstacles to export efforts. Only after the release of Nelson Mandela from jail in 1990, diddomestic pro-export policy and international receptiveness to South African products begin to bealigned.

The 1993 field survey sought to learn Table 7: Outward Orientation And Enterpriseto what extent South Africa's SMEs Performancehave responded to the shift inincentives towards increased exports,

EMPLOYMENT EXPORT/SALESand to increased international CHANGE

receptiveness. In four subsectors 1991-93

(auto parts, plastic products, Zero J19/o 10% or MoreDown 25% 39% 19% 14%

footwear and furniture), an explicit Down 0-25 33 28 22effort was made to iicorporate Up 0-25% 16 37 32

export-oriented SMEs among the Up 25% or More 12 16 32

surveyed firms. Comparison of the TOTAL 100% 100% 100%

experience of export-oriented firmswith others in the sample confirms Table 8: Export Sales, By Size Of Firmthe business and economic ,

advantages of exporting. As Table 7 FIRM SIZE

highlights, between 1991 anid 1993 (Number of Employees)

almost three-quarters of the firms |Expon/ 0-4 5-19 20-49 1 50-99 100+ ALL

that produced exclusively for the Sales j l l l

domestic market suffered job losses, l A. Allversus only one-third of the firms 0% 10 21 23 13 14 81

that exported at least I 0 percent of 159% 0 0 4 9 5 128

production. By contrast, one-third of 10-19% 0 ____2 13 17

the serious exporters, but only 10 20% 1 2 1 5 8 17

percent of the entirely inward- ALL 12 25 36 34 54 161

looking enterprises expanded 1 00/o B. Of Which Africa Exports Only:

employment by at least 25 percent. 14% - I 6 2 10 19

5-9% 2 4 3 3 10Overall, despite the business 1 0-19% o 7 8

advantages of exporting, export 20 I 0 62 1 39

performance was modest. As Table l Exportrs, ExcIud ng Afrcan On ly

8 , t u o0% 10 24 33 19 35 121percent or more of sales for only 17 1-4% ° 0 3 4 9of the 161 firms surveyed. Half of I590 % 0 0 6 2 8

the firms did not export at all, and a 101% o o 7 | 15

further 17 percent exported less than ALL 12 25 36 34 54 1615 percent of sales. Moreover, as

Page 8

The Btusiness EnvironmenteforSouth Africa s Indutstrial SMEs

Table 8B and C show, even these data overstate the extent of SME exports: half the "exporting"firms sell only to the African market (mostly to neighboring Southern African countries).Exports to non-African markets account for 5 percent or more of sales for only 31 firms. 18 ofwhich are in the auto parts and plastic products industries. Consistent with patterns the worldover, these exporters do not come from the ranks of the smallest firms: 27 of the 31 have 50 ormore employees.

Table 9: The Timing Of Thie Entry IntoIn interpreting these modest results, it is Export Markets

important to recall that only since 1990 could Southi (Number o Firnis)

African firms begin to feel confident that they YE-ARS OF EXPOR1

would be welcomed back into the internationialcommunity. Indeed, as Table 9 shows, II of the 22 xExporn/Sales 1480 98 19 1990 AL

firms which export at least IO percent of sales (and Erle 1- 86- -93 L

for which information was available) began r

exporting in 1990 or later. [Although the fact that 5-9% 1 3 _ 2 7

17 firms made their move into export markets prior 10-19% ( 3 4 8

to 1990 confirms that external markets were not as 2220%+ 2 O 7 4

closed to South African firms during the sanctions Age at Ist Export.

period as they might superficially have appeared.] 0-4 years 2 3

Again, the entrepreneurial initiative seems to come 5-9 years - 10 II

disproportionately from younger firms: 16 of the 22 10-19 years 1 I 7 6

"10 percent or more" exporters have been in 20 years + 1 2 29

business for less than twenty years.

An overview of sample performance.

In all, judging by the firms surveyed, performance of South Africa's existing SMEsappears to be solid, though hardly stellar. Participation in export markets remains modest, buthas risen substantially in the wake of pro-export policy reforms in the 1980s and the politicalopening of 1990, signaling that many of South Africa's SMEs are indeed responsive to newmarket opportunities. Moreover, a small minority of high flyers have shown genuine success increating jobs, taken together, employment in the I I firms in Table I I went from less than 100 atstart-up to 2,400 by the time of the firm survey.

Yet, while the demise of apartheid has facilitated entry by entrepreneurs other thanwhite, almost 65 percent of all firms sampled have been in business for at least 10 years -- andhalf of these for at least 20 years. Their performance has been typical of what might be expectedfrom senescent firms: little expansion; limited responsiveness to changing market signals.Moreover, since sample selection was skewed towards dynamic performers plus entrepreneursother than white, it seems likely that these "rump" firms are under-represented in the samplerelative to the aggregate population of industrial SMEs.

South Africa's emerging industrial strategy gives central importance to an expansion ofemployment in light-labor intensive segments of manufacturing, with particular emphasis onexport growth in niche markets. In principle, such a strategy seems especially suited to SMEs.Yet, not only are SMEs under-represented in South Africa's manufacturing sector relative tointernational norms, judging by the sample, only a small fraction of the SMEs are genuinelydynamic. Since young enterprises tend to grow most rapidly, and since the ceiling on expansionseems substantially higher for educated entrepreneurs, one challenge will be to encourage entry

Page 9

The Business Environment for South Africa s Industrial SMVE.Y

and participation in export markets by a new generationl ot educated entrepreneurs. A secondchallenge will be to revitalize established SMEs. so that they too can contribute to South Africa'sprogram of reconstruction and development. As a starting point to meet this challenges. it isnecessary to understand more clearly what are the constrainits that presently hold back SMEs.

III: CONSTRAINTS ON SME PERFORMANCE: AN OVERVIEW

Sample enterprises were presented with a set of sixteen potential obstacles to futureoperation or expansion and asked to rank each of them on a I (no obstacle) to 5 (severe obstacle)scale. As Table 10 shows, firms reported overwhelmingly that their most difficult obstacleswere those associated with political/policy uncertainty, and the weak South African economy.Note, though, that since the time of the survey South Africa has successfully competed itspolitical transition, and its economy has begun to recover, so these obstacles may no longer loomas large.

A second tier of constraints, high taxes, interest rates and wages, all raise the costs ofproduction to firms. Experience elsewhere suggests that high scores for cost constraints signalsthat enterprises are feeling a profits squeeze, with no necessary implication one way or the otheras to whether the relevant prices are too high in an economic sense. (Evaluating whether theseprices are indeed "too high" requires a very different type of date and analysis than can beconducted via firn surveys).

Four additional groups of constraints are noteworthy. The group of constraintsassociated with non-competitive domestic markets will be examined markets will be examinedin chapter 4 of this report. The remainder of this subsection will examine constraints associatedwith lack of access to finance; human resource constraints; any regulatory constraints, includingindustrial relations.

Table 10: Obstacles To Expansion Of SMEs

I Average Score % RespondingI or 2 (A) 4 or 5 (B)

Political/policy uncertainty 4.29 9.7% 78.2%Weak South African economy 4.20 9.7% 75.8%High level taxes 3.69 17.6% 61.8%High cost of bank finance 3.37 26.7% 53.9%High Wages 3.06 35.2% 40.6%Problems accessing export markets 2.82 29.7% 21.2%Industrial relations (including industrial council 2.61 46.7% 32.7%Scarcity of competent workers 2.56 48.5% 26.1%Problem with providing credit to customers 2.55 45.5% 27.9%Lack of skilled technicians 2.48 55.2% 2 1.8%Lack of managerial skills 2.41 51.5% 20.6%Problems with government bureaucracy 2.34 60.0% 21.8%

Lack if access to bank finance 2.27 63.6% 24.2%XDifficult to penetrate non-competitivelDomestic markets 1.99 67.3% 14.5%

Problems with procurement of inputs 1.96 69.7% 10.9%Problems with access to suitable premises 1.40 86.1% 3.6%

Page 10

The Business Environmentfor South 4frica's Industrial SMt-Es

Access to finance.

Lack of access to finance scores strikingly low in Table 10 as a constraint on enterpriseexpansion. This result is surprising in light of thie common view that, since South Africa'sdominant banks owned by the country's major businless groups, they skew their activities to largeenterprises within their own business stable, and neglect small firms.

A common further criticism is that the banks tend to discriminate against businessborrowers other than white. It is thus useful to draw on the survey data to probe more deeplyinto how the bankinig system operates for SME,s.

Banks (appropriately) evaluate loan requests in relation to their riskiness and transactioncosts. Consequently the world over, even in well-developed banking systems, banks are wary ofmaking loans to start-up firms, to young firms. and to small firms. The questions that are key inevaluating access to finance by SMEs are how much experience a firm needs to save prior toobtaining a loan, what size it needs to be, and what collateral is required. While at first sight,v iewed in relation to such criteria. South Africa's banking system performs well, with furtherprobing a more mixed record becomes evident.

Table I I disaggregates Table I1: Constraint Scores For Lack Of Access To Finance, By Size Andthe constraint score for lack of Age Of Firmaccess to finance according to (Number of Firms in Brackets)the size and current age of tile Aee ALL

143 firms which providled the l. ~(Current 0-4 Years i-19 years 20+ years ILrequisite information. The 1-4 4 0 2.5 37

results follow the expected (7) (3) (3) (12)

pattern for a well-functioning |3. 3.3 2.3 3.2(7) (14) (3) (24)

banking system: the relative 20-49 2.8 2.6 ( 8 2.3

importance of the finance (5) (15) (12) (32)

conistraints declines 50-99 I ( 2.3 1.9 2.1(2) (18) (I 0) (30)

systematically with age and 100- - 1.8 1.7 (.8

size -- firms that had twenty or (19) (26) (45)

more employees, and that had All 3.0 2.5 1.8 2.3'___________________ (2 1) (69) (53) (143)

been in business for more thanfour years reported themselves to be, at most. only moderately constrained in their access tofinance. In addition to overall constraint scores, 57 firms provided information on their age andsize at the time they received their first loans. Twenty-two of them (almost 40 percent) receivedloans within the first year of operation. and an additional 17 (30 percent) within the first threeyears. Twelve firms had 3 or fewer employees at the time of the first loan, while an additional20 firms had ten or fewer employees. Clearly, even small and new firms have access to SouthAfrica's banking system.

The world over, commercial bankers require collateral for their loans. South Africa'sbankers appear no more demanding than the norrn: as Table 12A shows, 60 percent of borrowershad to provide collateral equal to at least 100 percent of the value of their loans. Predictably,given the greater uncertainties attached to loans to small firms, collateral requirementsdecreased with firm size. Collateral equal to 100% or more of loan value was required from

Page I I

The Business Environment for Southl Africa 's lndustrial S,'IfE.v

86% of SMEs ( 12 ot 14) with fewer than 20 employees, but from only 43% of SMEs (16 of 37)with 50 or more workers.

Relative to many other developing Table 12: Loan Collateralcountries, South Africa's bank system is A: Collateral/Loan ii Current Loa || First Loan

unusually flexible as to what it accepts as % %of Fim (% of Firm)collateral. In many developing countries, only _ _ _ _ 33O 34%

5 1 -L9 7 6immovable property is acceptable. By Il( ( 34 36

contrast, as Table 14B shows, for both initial Above 100 26 24

and current loans fewer than half the South Total I00 l5_

African Firns surveyed provided collateral in Number of 70 47

the form of immovable property. Taken Respondents C'ollateral

together, equipment (often purchased with the Immovable Properly 44% 48°loan's proceeds), debtors' books, and insurance Equipment 22 24

policies were at least as important as Debtor's Book 16 10Insurance Policies 5 10immovables as sources of collateral. This Other 13 8

unusually expansive definition of what is Total 100%acceptable as collateral reflects the high level Number of 79% 4

of development of South Africa's legal Respondents l_I

institutions. Note, though, that this broad definition was of more help to larger than smallerfirms: immovables were required as collateral from 69 percent (9 of 13) of SMEs with fewerthani 20 employees, but from only 38 percent (10 of 26) of SMEs with 100 or more employees.Interestingly, younger firms were at least as likely to be able to use moveables as collateral aswere their older counterparts.

Though South Africa'sfinancial system seems to operate well Table 13: Racial Differences In Constraint Scores For Accesswhenanealuaysted through the operism ofl To Finance Among Firms Active For Under 20 Yearswvhen evaluated through the prism ofsize and age, performance seems more C At_ican ndia W

Current fAtrican Core Inia White Allproblematic once ethnic variables are Emplovee

incorporated into the analysis. As sTable 13 shows, within virtually all 1-4 50 5.0 2.0 I0 3.9

size categories lack of access to 3 S-19 (6) 3 8I) (2) (10)g 5-19 ~~~~ ~~~~ ~~~~ ~~~~4.0 383.5 2.0 3.3finance emerges as a more binding (4) (4) (8) (5) (21)

constraint for African entrepreneurs 20-49 - - 3.1 2.3 2.7

than for their mixed-race counterparts, __5-991 (8) (12) (20)50-99 -1.0 2.0 2.4 2.3and as more binding for mixed-race (i) (4) (14) (19)

owned firms than for those that are I00- - - 1.8 1.8

Indian-or white-owned. 6 Indeed, for l (12) (19)

all size categories the scores for white-owned firms are astonishingly low. The 1991 garmentsurvey yielded parallel results: on a 1-5 scale, the average score for 12 African or mixed-raceowned garment firms that had been in business for five or more years, and had 5 or moreemployees was 5.0

Enterprises that are 20 or more years old are excluded because the sample incorporated only wvhite and Indian fimis in that agecategory, and because there was no significant difference between these groups in the constraint scores.

7The equivalent score in the garment survey for Indian and white-owned firms was 3.0. Oddly, the average score for black andcoloured-owned firms with fewer than five employees and fewer than five years in business was only 4.4 -- although this resultappears to be an artifact of how the sample of these smallest firms was drawn (predominantly via NGOs which also providedfinancial support).

Page 12

The Bzl*lnevs Environment.for Soth Africa's Industrial SMUEs

Twenty-eight firms without bank loans Table 14: Ethnic Differences In The Factors Accountingranked (on a I to 5 scale) a series of For The Lack Of A Bank Loanexplanations as to why they had not (I= least important; 5= most important)

borrowed. As Table 14 shows, All Firms African- Mixed- Indian Whiteinteresting racial differences were Owned Race Owned Owned

apparent. For white-owned firms, Owned

virtually the only reasons for not having No Desireto Borrow 3.4 1.9 3.0 3.5 5.0a loan were that they preferred not to High

borrow, or that interest rates were too Interest Rates 3.9 4.6 2.0 4.3 2.9

high. By contrast, collateral- Collateralrequirementsloomed large forARequirements 3.5 4.2 3.0 4.2 1.9requirements loomed large for African- Need Financial

and-Indian-owned firms. Further, Documents 2.0 3.1 3.0 1.5 l IAfrican-owned enterprises in particular Need Deposit

were disproportionately likely to score Track Record 1.7 2.6 1.0 1.6 1.0

high the constraint that "banks are Connections 2.0 2.6 1.5 1.9 1.6

prejudiced against firms like mine."8 FirmntooSmall 2.0 2.8 2.0 1.9 1.0There was no evidence of discriminatory Firm too New 1.9 2.7 2.5 1.6 1.0

ethnic variations in the type of collateral Banks are

required, with moveables widely prejudiced

accepted as collateral regardless of against firms like 2.5 4.1 2 0 2.3 1 0mineIIIethnic origin. Number of Firms 28 9 2 10 7

Human resource constraints.

Human resource problems -- Table 15: Human Resources Constraintslack of skilled technicians, of skilled Or Enterprise Expansionmanagement, and of competent workers (I=no obstacle; 5=major obstacle)-- scored in the middle range of theconstraints included in Table 10. Table Firm Size Lack of Lack of Lack of

15 disaggregates these constraint scores (Number of Skilled Management Competentemployees) Technicians Skills Workers

by size offirm. Two striking patterns 0-1 2.0 2.4 2.3emerge. First, firms with fewer than 50 5-19 1.7 1.9 1.8workers consistently score human 20-49 2.3 2.2 2.5

,r 50-99 1 3.1 2.6 3.0resource constraints lower than do larger 500 or more 2.8 2.8 2.6firms--- perhaps because smaller firms -o

engage in simpler production and areless conscious of the need for more sophisticated skills, perhaps because they are small enoughto be able to identify employees through community networks and hence are less dependent onimpersonal labor markets. Second, both the "skilled technician" and the "competent worker"constraint appear most serious for firms with 50-99 workers, rather than the largest size category.One plausible interpretation of this pattern is that enterprises "grow into" human resourceproblems, but subsequently can "grow out" of them by strengthening their staff management andtraining procedures.

Verv similar patters were evident for 23 additional firms which had loans, but were constrained in their access to additional loanfinance from banks.

Page 13

The Business Environment for South Africa 's Indu'strial SMEs

Regulatory and industrial relations constraints.

Regulatory and industrial relations Table 16: Difficult External Agenciesconstraints emerge in Table 10 as moderate-to- (Number of Respondents)low constraints on SME performance. To | fMost Second Third Mostprobe further, interviewees were asked to l difficultidentify (in rank order) which agencies Trade Unions 61 15

external to the firm (including local and central Industrial Councils29 16 __ _ __ _ _

government officials, police, tax authorities, Tax Authorities 6 l 3trade unions and industrial council officials) Central or Localcause them the greatest difficulties in operating Governments 4 6 1

Other 4 4 Itheir businesses. As Table 16 shows, industrial Number ofrelations issues dominate: trade unions or Respondents 104 42 7

industrial councils (bodies which have thelegal mandate to enforce agreements reachedby collective bargaining) were identified as the Table 17: The Extent Of Unionismmost difficult agency by 86 percent of all (Number of Finns)respondents.

Finn Size .Tables 17 and 1 8 provide further Employees) Unioon 50 Over 50/o Total

insight into industrial relations issues. As UnionTable 17 reveals, the level of unionization rises - izationmonotonically with firm size. The smallest 0-4 15 l 24

firms are virtually entirely un-unionized, and 20-49 8 1 27 36

(as Table 18 shows) for this group of 50-99 4 6 22 32

interviewees industrial relations are in no way loo+ 4 3 45 52Total 42 12 102 156

an obstacle to enterprise operation orexpansion. As enterprise size expands, theextent of unionization increases -- and so, too, does the extent to which firms perceive industrialrelations as an obstacle. Interestingly, paralleling the earlier results for human resources,problems with industrial relations appear to peak among firms with 50-99 employees, again,perhaps, because the largest firms are better positioned to professionalize their industrialrelations. [It remains uncertain how implementation of the 1995 Labour Relations Act will affectthese results. On the one hand. it could provide a better balanced system of industrial relations,reducing transactions costs for all. On the other, broader application could create for smallerfirms the problems with industrial relations evident in Table 18.]

Almost as striking as the dominancelabor-related bodies in Table 16, is the Table 18: Industrial Relations And Regulatory Problemsexceedingly limited number of mentions of As Constraints On Enterprise Expansionany other public authority. Even though (I=no obstacles; 5=major obstacles)interviewees were explicitly encouraged to

Firm Size I Other Governmentlist up to three external agencies, tax Number of Employees Industrial Relations Bureaucracyauthorities, and "other" each were identified l

by fewer than 10 percent of firms as being 0-4 1.0 1.8

an obstacle to enterprise operation. Note, 5-9 2.4 2.0an enterprise 20~~~ ~ ~~~ ~ ~~~~~~-49 3.0 2.0though, that Table 18 suggests that firms 50-99 3.2 2.6

with 50 or more employees (though not their I 00 or more 2.4 2.8

smaller counterparts) do experience

Page 14

The Business Environmenefor South Africa 's Industrial SMEs

government bureaticracy as a mid-level constraint. Taken together, the data in Tables 16 and 18suggest that for the larger firms, red-tape is not entirely trivial.'

IV: INDUSTRY STRUCTURE, COMPETITIVE CONDUCT AND SMEPERFORMANCE

IV.: The Setting

This chapter uses the firm surveys to explore in depth a fourth set of constraints -- theextent to which South Africa's high levels of industrial and conglomerate concentration inhibitSMEs. The firm surveys probed the perceptionis of SMEs as to the competitive environment inthe footwear, fumniture, plastic products and metal fixtures subsectors. It is important toacknowledge up front the limitations of relying on firms' perceptionis to assess the impact ofconcentration on the busilless enviromilent for SMEs. First, respondents may ascribe their ownweaknesses or failures to problems and features of the external environment. Alternatively,better performing firmns might underestimate the impact of competitive barriers on their lessdynamic counterparts. A further limitation is that the respondents themselves may notunderstand the precise meaning of the concepts related to anticompetitive behavior. It ispossible, for example, for respondents to interpret as "unfair trade practices" competitive actionswhich are aggressive but nevertheless legitimate from a competition policy point of view.

Yet for all these limitations, it is the enterprises themselves that have the most directexperience with the environment in which they operate, and with the conduct of the various firmswith which they do business. While their perceptions as to the presence (or absence) ofnoncompetitive behavior do not constitute proof, they offer a compelling starting point for anysubsequent studies which might be undertaken.

Table 19 details South Africa's three-firmconc entr tinatios arossh 76rica's thTable 19: Three-Firm Concentration In South Africa'"

firm concentration ratios across 176 o

subsectors of manufacturing at three points in of three Percentage of

time. As the table shows, the levels of largest Firms Number of Subsectors Subsectors

industrial concentration have consistently [in Each Subsector

been high. On average, the leading three ( 197 198 198 1972 1982 1985

firms account for 56 percent of sales in 2 2 5

individual subsectors. (Average 0.00-0.20 17 14 129.4 8.0 8.0 6.9

concentration for 1985, weighted by 0.20-0.40 52 45 36 28.7 25.6 20.6

subsectoral production shares, amounts to 49 0.60-0.80 32 44 41 17.7 25.5 23.4

percent). As of 1985. three-firm 0.80-1.00 45 33 41 24.9 18.8 23.4

concentration ratios exceeded 60 percent in Unweighted 56.5 55.0 56.2

almost 47 percent of the subsectors. AverageC3 =

Along with high industrial concentration at the subsectoral level, South African industryalso is characterized by a very high level of concentration of ownership. Unlike the United

9 The one bureaucratic requirement that received repeated mention was for firms to "do the job of inland revenue" -- manage taxpayments for their employees (including liability for non-payment).

' source: Republic of South Africa. Central Statistical Services, Census of Manufacturing

Page 15

The Business Environment for South Africa 's Industrial SAIEs

States or the United Kingdom, South Africani Table 20: Group Control On Johannesburgcorporate law pen-nits the establishmenit of Exchange

(Share of Market Capitalization)pyramid holdingcompanies, whichl enableCnroig dy 18187 -

rControlling Bod 1983 1987 1991business groups to maintain control over | Anglo American 52.5% 56.1% 42.4%individual operating entities even with a small Renmbrandt 2.1 4.9 15.2

direct ownership stake. In consequence, as Sanlam 9.4 9.7 13.2

Table 20 shows, as of 1991 enterprises unider the SA Mutual 0.6 8.9 10.41Next Largest Group* 2.8 5.5 7.6

control of the four leading business groups Others 32.6 11.4 11.2

accounted for over 81 percent of the market IOTAL 100.0 100.01 100.0

capitalizationi of the Johannesburg Stock So-r- IMcC-gor, OM- 1formand Semces

Exchange (JSE), with the Anglo American/DeBeers Group alone accounting for 42% of the total."

The fact that South Africa's levels of industrial and conglomerate concentration are highdoes not make it inevitable that economic performance will be poor, or that SMEs will bevictims of anti-competitive behavior. Indeed, countries as diverse as Korea and Sweden havebuilt powerful industrial economies on the foundation of a small number of giant businessgrotips. What is crucial is the (policy-influenced) behavior that is associated with highconcentration. In the South African context, the firm surveys can help to clarify what in practiceis the impact of concentration on SMEs.

In Table 10, the two concentration-related obstacles to SME expansion -- difficultypenetrating non-competitive domestic markets, and problems with procurement of inputs --ranked virtually last among SME constraints. Yet constraint rankings such as these can concealas much as they reveal. Consequently, the firm survey sought to probe in depth the way in whichindustrial organization influenced the performance of SMEs.

IV.2: The Analytical Framework

One goal of the empirical analysis was to distinguish clearly between those factorswhich are the result of anti-competitive behavior and (though perhaps difficult in practice) inprinciple could be relaxed or removed through the enforcement of instruments of competitionpolicy, and those which lie beyond the appropriate boundaries of competition policy. To makethis distinction, it is useful to categorize the various competition-related factors examined in thefirm surveys under three headings. The first set of factors comprise "strategic" barriers toperformance, that is they arise from anti competitive behavior by rivals, suppliers, or purchasers.These constraints constitute the proper target for competition policy. The second set of factorsattempts to capture various disadvantages which can be directly attributed to "enterprise

" While Anglo American has disputed this number, as of 1990, the Group chairman conceded that his company controlled 30% ofthe value of JSE assets -- although it was unclear whether he included De Beers holdings in his estimate. 145 distinct publiclyquoted companies (some ol'which themselves comprise more than one operating enterprise) are part of the Anglo group alone. Thepyramid structure permitted such a broad span of control even though the average direct ownership stake of pyramid companies(e.g. Anglo American Corporation and Rembrandt) was 17 percent, with the corresponding average for mutual contractual savinginstitutions (e.g. Old Mutual and Sanlam) amounting to 26 percent. Note, though, that these data are based on market capitalization.Using other measures, the share of business groups is smaller. Thus, tvo-thirds of a sample of 196 firms quoted on the JSE wereindependent of the five leading groups. And since the sample targeted for inclusion the largest firms on the ISE. the share ofindependents in the more than 400 companies quoted on the industrial board of the JSE is certain to be substantially higher.Resolution of the apparent conflict between the high share by capitalization and lower share by number lies in the larger size offirms under the control of big business groups. On average operating companies controlled by the five leading business groups haveover five times the number of employees. and almost seven times the value of assets, than other publicly quoted companies.

Page 16

The Business Environmentfor South Africa's Industrial SMEs

specific" characteristics (such as being small, inability to exploit various forms of scaleeconomies- or lacking technology to produce high quality products). The third set of factors are"entrepreneur-specific", that is they are related to personal characteristics of enterpriseproprietors, their ethnic background, the social networks in which they are embedded etc.

Table 21 summarizes the Table 21: Survey Instruments Approach To Constraints Smes ShareIn Intermediate Input And Output Markets

structure of the survey instrumentregarding competition in the OUTPUT MARKETS

surveyed finns' input and outputmarkets. The paragraphs that Why is it difficult to enter new Strategic Factorsfollow describe how each factor domestic markets? Vertical preferences

. Unfair competitive practiceswas incorporated in the survey. by competitors

(vertical restraints, predatory pricing, etc.)

Strategicfactors. Enterprise Specific

Sales volume

Three distinct types of Reputation/information costs

strategic barriers to the E Prejudice

performance of small independentmanufacturers can bedistinguished: seller collusion; . Whv do your suppliers collude? Strategic Factors

purchaser collusion; and vertical . Vertical preferences

preferential treatment (in both . Why do you pay more forinputs? ~~~~~~~~~Enterprise Specific

input and output markets). inputs?Volume-boughtReputation/Anformation costs

To begin with upstream Entrepreneur Specific

input markets, industrial . Prejudice

concentration is high for many ofthe upstream industries whichproduce the mair `nuts for thesubsectors for v surveys were undertaken. This raises the question of whether concentrationleads to seller co.. -,on in the market for inputs, raising the input costs of downstream users, andhindering the entry of marginal firms. Conglomerate concentration could compound theproblems of firms downstream. It could result in vertical preferential relations among firmsrelated through ownership.'2 In the extreme case, the upstream firm could refuse to supply anyfirm other than the one with which it has ownership ties, leading to a situation of verticalforeclosure. A further possibility is that the upstream firm may charge a higher price to theindependent downstream producer, or may restrict sales to it, putting it at a competitivedisadvantage relative to the related firm.'3

12Two further potential consequences of conglomerate concentration are noteworthy. First, since South Africa's major bankinggroups each are owned by one or another business group. it has often been conjectured that entry into industry by independentcompetitors could be restricted via constraints on access to finance. The evidence m section II does not, however, offer any supportfor this conjecture. Sccond, high levels of ownership concentration (in the context of a domestic-market orientation) could result inthe practice of "mutual forbearance" among business groups, with each recognizing their respective zones of dominance andrefraining from mutually "destructive" competitive investments. While the evidence presented here does not directly address theseconcems, some of the broader policy implications of the analysis will indeed turn out to be relevant to the problem of mutualforbearance.

13 Note that this can occur only if the upstream producer or producers are able to exercise market power.

Pave 17

The Business Environment for South Africa 's Industrial SMEs

The survey instrument seeks to gauge the existence of seller collusion and verticalpreferences by asking respondents whether they believe that there is collusion among majorinput suppliers, and whether they pay more than their competitors for their inputs. Since payingmore for inputs in itself does not provide evidence of anti-competitive behavior by suppliers, thequestionnaire further inquires about the reasons for paying more.

Turning to downstream output markets, again both industrial and conglomerateconcentration could constrain SMEs. Purchasers (further downstream industrial producers, orwholesalers and retailers) might exert monopoly power. As in input markets, this would lowerthe margins of producers and prevent the entry of marginal firms. Vertical preferential treatmentalso might be relevant downstream, with purchasers preferring to buy from producers with whichthey have ownership ties. This can be thought of as an extreme case of exclusive dealing.Further, rival producers may engage in anti-competitive behavior such as predatory pricing, orimposing vertical restraints on distributors (other than those with which they have ownershipI inks).

The questionnaire addresses competition policy concerns in the output market by firstasking the respondents for their perceptions about whether it is difficult to enter new markets. Itthen requests the respondents to rank the importance of various reasons for these difficulties witha score that ranges from I (not important) to 5 (very important). The factor "outlet favorssuppliers with ownership/family ties" captures vertical preferences by purchasers. Otherpossible forms of potentially anti-competitive behavior, such as retail price maintenance, orpredatory pricing are subsumed under the factor "competitors use unfair trade practices". (Notethat the survey analysis of output markets does not address the possibility that oligopolisticbuyers appropriate rents from producers by depressing the output price, thereby constrainingopportunities for expansion. A number of SMEs alleged that such behavior was prevalent.)

Enterprise-specficfatctors.

A wide variety of enterprise-specific factors may affect the performance of SMEs. Onefactor is the price/quality competitiveness of the firm relative to the rest of the market. A secondfactor focuses on competitive disadvantages directly associated with being small, that is,inability to buy or sell in large enough volumes. In the case of input markets, fixed transactionscosts and (insufficient) volume of purchases may explain why a firm may have to pay more forinputs than its competitors. In the case of output markets, inability to produce large enoughvolumes may, in addition to increasing average cost, hinder entry into new market outlets wherepurchasers such as retail chains seek minimum volumes.

Another important set of barriers concerns the information-related transactions costswhich characterize input or output markets. The argument is that imperfections in informationabout qualities of suppliers or purchasers place newcomers in a market at a disadvantage relativeto incumbents. Whereas incumbents can enjoy an already established "reputation capital", newentrants would have to pay an information premium until, through repeated transactions, they areable to convey to the market credible information, for example, that they are reliable suppliers,or that they can be entrusted to purchase on credit. In addition, relative to new entrants, thosewho have operated in a market for some time would have access to more information about

Page 18

The Business Environmiientfor South Africa's Industrial SMEs

prices and products of different potential business partners, and about the nature of thecompetition and business practices."'4 These will be called costs of reputation and information.

The survey instrument addresses these factors in the following way: for intermediateinput markets, it offers, as reasons for paying more than the firm's competitors for inputs, thiat"the competitors buy in larger volumes" and that "it takes time to build the relationship which areimportant for obtaining reliable supply at competitive prices." The second item capturesreputation costs. For the output markets, the survey offers similar reasons for difficulties facedin entering new markets with the added factors which capture price and quality competitiveness.

Entrepreneur-specificfactors.

In two instances, the survey instrument attempts to capture directly perceived ethnicallybased discriminatory behavior in the intermediate input and output markets. In the first instance,prejudice against "firms like mine" is provided as an explanation to why a firm may pay morethan its competitors for intermediate inputs provided by domestic suppliers. In the second.prejudice by a market outlet is offered as an explanation of why a firm may face difficulties inentering that market outlet.

In addition to documenting evidence on perceptions of discrimination, an attempt will bemade to see if ethnicity plays any independent role in explaining cross-firm variations inresponses. Efforts in this area are limited by the extent of diversity in the sample: Among theindustries in which the survey was carried out, only the metal fixtures sample contained anyAfrican entrepreneurs. However, Asian and mixed-race entrepreneurs comprised one-third ofthe furniture sample and more than half of the footwear sample.

IV.3: The Main Results

The survey focused on subsectors in which the costs of initial entry were low, and thenumber of participants consequently large:

* In furniture, as of 1985, at the 5-digit SIC level, there were more than 1,000firms in the industry. The largest eight establishments accounted for 24 percentof sales. Further disaggregation, plus adjustments for the multi-establishmentnature of the leading firms, reveals somewhat more concentration: AFCOL, thelargest group in the industry, produces about 40% of the household furnituremarket; and the share of the leading office furniture producer is similarly about40%.

* In plastic products, the number of plants has increased from 507 in 1985 toabout 1,000 in 1992. As of 1985, the largest four establishments accounted for12% of all sales.

* Footwear is a mildly concentrated activity. The single largest footwear group(CONSHU) accounted in 1993 for 30-35% of total domestic production; the five largest

14 See Levy (1994) for empirical evidence on the value of belonging to network, where the cost of resolving such information andreputation problems are relatively low.

Page 19

The Business Environmentifor Souti Africa s hIduistrial S,lEs

groups accounted for 50-60%. As of 1985, the four-establishment concentration ratiowas 36%, and the eight-establishment ratio was 49%; 147 formal establishments wereactive in the subsector. In recent vears, the number of small firms (those with a capacitybelow 100,000 pairs per year) has been increasing, to reach 123 in 1992.

* The fabricated metal products industry, and in particular the household metal fixturessubsector is largely dominated by SMEs. In 1985. the largest four firms in the varioussubsectors (ISIC 38120. 38130. 38132) accounted for 29-33% of sales; the share of thetop 8 firms was 38-48%. There was a total of 446 establishments in the ISIC categories.

Although the selected subsectors are themselves thus highly competitive, the patterns ofcompetition in relation to input suppliers and buyers require more careful examination.

Product markets. 'Table 22: Competition Policy Concems

Output Markets

Two of the four % of firmlssubsectors studied (furniture and | Sectors which find it Vertical Other unfair

subsector stuie(udifficult to enter preterential trade practicesfootwear) produce consumer new markets exchangegoods which are predominiantly No. The main problem is contraction ofmarketed through retailers. In the Furniture 35%o No production and distribution

minduced by a recession.remaining two subsectors (metal No. Firms are mainly constrained by

engineering/fixtures and plastic Footwear 44% No costs associated with building reputation

products), subcontracting plays a in new market outlets.products), subcontracting plays a No. Output volume too small tomore important role.. Plastic 70% No. penetrate new markets.

Converter

It has often been alleged sItlhas often been alleged Mild evidence expressed by Africanthat South Africa's highly Metal 56% No. entrepreneurs. Main constraints are

concentrated structure of retailing Fixtures costs of building reputation and lackor price competitiveness.

poses major obstacles to entry andexpansion by SMEs. At firstglance, the furniture industry Table 23: Market Outlets For Sample SMEs

offers a classic examnple ofthe utiet ype Furniture o Footwear Plastic Metalproblem. According to the Products Fixtures

Furniture Traders Association, Retail Chains

nine major groups own about 80- 20% 35%90% of all outlets. Four major Individual

Retailers 45 24 -groups dominate the industry: Traders

Rusfurn/the JD Group (these had and Wholesalers 4 29 18% -

been competitors Lintil the JD Subcontractors& Principals - 53 27%

Group acquired Rusfurn in 1993); Direct toEllerines; OK Bazaars, and Amrel Consumers 23 15 65

(the latter two are owned by Other 8 I 14 8TOTAL 100% 100% 100% 100%

South African Breweries, itselfcontrolled by Anglos; Afcol -- thecountry's largest furnitureproducer -- also is controlled by South African Breweries).

Yet Tables 22 and 23 belie the expectation that this concentrated structure results inserious obstacles for SMEs. As Table 22 shows, only a minority of the sample furniture and

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The Business Environment for South Africa 's Industrial SMEs

footwear SMEs reported it to be difficult to penetrate new markets. Table 23 helps clarify thereason for this result: only one-fifth of the sales of SME furniture firms , and one third of thesales of footwear firms, went to the large retail chains. The bulk of sales were channeled throughother outlets: independent retailers, traders, wholesalers, direct sales to consumers and the like.It would be wrong to conclude that these other outlets represent market "backwaters" in whichSMEs, excluded from the primary retail outlets, are forced to congregate. In furniture, forexample, the most dynamic and successful firms targeted for increased sales local niche markets(high-income consumers and corporate clients) rather than chains. These results suggest that theseeming dominance of large retailers obscures a substantially more varied, and competitive, setof retailing mechanisms than first meets the eye.

Among the minority of Table 24: Perceived Reasons Forfurniture and footwear firms that Difficulties In Penetrating New Marketsreported it to be difficult topenetrate new markets, most fFootwear Fuiture Conveners

were indeed targeting the large Firm not able to produce volume .

retail chains. Yet, as Table 24 sought by outlet 4.1 3.0 1.7 3.9

shows, few of these firms Takes time for any new supplier topenetrate outlet 2.7 4.54 2.0 4.1

perceived their difficulties to be Outlet is unwilling to give smaller

related to either preferential firms a chance 2.3 2.0 1.8 3.5

vertical relations or unfaircomertitive practices. Rather, Firm no yet price competitive 2.2 1.7 2.1 3.5competitive prcie.Rte, Firm's quality and reliability notthe principal obstacles were up to standard 1.5 1.4 1.5 1.9

their inability to produce the IOutlet favors suppliers withrequisite volume, and that it ownership/family ties 1.0 2.5 2.0 1.9

Outlet is prejudiced against firmswould take additional time for like mine 1.0 2.3 1.5 2.9

them to build the solid My competition uses unfair

reputation needed before chain competitive practices 0.9 1.8 2.2 3.0

buyers would place orders with Number of respondents 10 5 20 20

them.

In the more subcontracting-oriented plastic products and metal fixtures subsectors, ahigher proportion of firms reported it to be difficult to penetrate new markets (see Table 22).Again, though, the detailed results do not strongly support the view that "outsiders" are blockedfrom participating in subcontracting relations. For both plastics and metals firms, relatively highscores were given to the factor "penetrating new outlets takes time", possibly suggesting theneed to build up a reputation. This result signals the importance of acquiring and revealingcredible information about possible partners in subcontracting relations, for which the costs ofnon-performance are substantially greater than in simple spot transactions. Note, though, thatplastics (but not metal) firms also scored high (relative to other factors in their respectivesubsectors) "outlet favors suppliers with ownership/family ties"and "my competition uses unfairbusiness practices".

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The Business Environment for South Africa's Industrial SMEs

Table 25: Some Output Market VariationsOne result does point, though, to Among Metal Fixtures

potential problems of preferential access Firm Size(although other interpretations of the survey Percentage Sales Under20 20 or Moreresponses are also plausible).' 5 In the metal to: Employees Employees

rSu bco ntrac to rs/fixtures subsector there are some noteworthy Principals 19% 44%differences in the market patterns for larger Direct toand smaller (predominantly) African Consumers 76 40subcontractors. As Table 25 shows, for firms Difficult to Enter New Marketswith 20 or more employees, subcontracting is Yes | 1 2 7marginally the more important outlet forproduction. By contrast, direct sales to consumers account for an overwhelming proportion ofthe business of smaller firms. Paralleling these results, 71 % of the smaller firms, but only 30%of their larger counterparts, reported it to be difficult to penetrate new markets. Nine of the 12small firns that reported difficulties in market penetration were African-owned. And 7 of theserated the prejudice item in Table 24 with a score of 4 or 5; this item has a mean score of 3.7among the African entrepreneurs. Eight also gave scores of 4 or 5 to the item "competitors useunfair business practices".

Input Markets:

In the selected subsectors, the markets for some key inputs were highlyconcentrated:

* For furniture, 90% of sawmillers are organized into the SA Lumber Millers Association, allegedby interviewees to behave like a cartel. Chipboard is supplied by two major suppliers, alsoalleged to collude in price.

* For plastics producers, the local manufacture of polymers is dominated by three domesticproducers --SASOL. AECI and Sentrachem.

* For footwear, five major groups own all the tanneries in South Africa; three of these groups alsoplay major roles in the livestock/hides industry.

* The production of steel is dominated by ISCOR. Highveld Steel and Scaw Metals also areproducers, however the degree of product overlap is low. The minimum size order of these majorproducers is far larger than the normal input requirements of most SMEs, who procure theirrequirements from steel merchants. There have been numerous complaints of collusion amongthe merchants. However, since production itself is highly concentrated, collusion amongmerchants seems unlikely to have much impact on the price paid by SMEs (rather, it affects thedistribution of rents in the industry between producers and distributors).

5 In his background paper on the metal fixture industry. Moss Ngoasheng reported that " discussions with black entrepreneurs,however indicated that it it difficult for them to find subcontracting principals. particularly among large formal constructioncompanies. Ther is a preception that racial attitudes play a role. This notwithstanding efidence from the survey which suggests thatthese fimis are unable to produce the volume required by the principals.' Ngoasheng (1993) p.7

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The Business Environnient for Soutth Africa's Indutstrial ShiEs

Table 26: Strategic Barriers In The SME SectorIN FERMEDIATE INPLJUr MARPKETS

Table 26 shows there to be - ot firnms Collusion among

a widespread but not unanimous SECTORS which believe Vertical prelerential suppliers

perception among interviewees of they pay more than exchanige (% of responidents)

collusion among their suppliers. competitors 5 I tWhile about 70% of interviewees in Furniture 14% No especially in inter-

the metal fabricators industry action with otherstructuiral barriers

believed that suppliers (mostly steel and especially fbr

merchants) colluded, this ratio was smaller firms.

only 38% in the footwear industry. No. Main reason (38%). Yes, but moreol38oIthfowa duty Footwear 38°'o l~ or widespread (43%)

and was concentrated among firms higher inpLtt prices among firms whose

using leather as their main primary is purchasing in main inputinput. In general, the perception of small volumes. is leather

input. In general,the perception of Plastic No Main reason (41%). Yes. but lesscollusion was more widespread converters 26% for paying more is for firms that importamong smaller firrms (except in the purchasing in small some of their inputs

footwear industry). T his finding volMinies. (265.%).No Main reason (69%). Yes.

may reflect that larger firms have Metal 67% for paying more is especially for smallermore bargaining power and can Fixtures purchasing in small lirms (83%).

strike better deals with suppliers. volumes

Table 27: Plastic Converters - Perceptions On Collusion And Effect Of ImportsNUMBER OF FIRMS

Firm Imports Do suppliers collude?Yes 9 Yes 3 (25%)

No 6 (75%)No Answer 7

No 13 Yes 8 (62%)No 5 (3%)

Both theory and evidence suggest that the extent to which high domestic concentration in inputmarkets translates into oligopolistic power varies with the degree of protection from import protection.Survey results, especially in the plastic converter and footwear industries, confirm that perceptionsabout seller collusion in input markets are affected by whether or not a firm imports some of its inputs.In the plastic converters industry, firms which imported some of their inputs were less likely to believein the existence of collusion (see Table 27). In the footwear industry the opposite was true,complicating the inference, but possibly suggesting that firms which relies on imported inputs had doneso as a result of their belief that sourcing from domestic markets would make them vulnerable toanticompetitive practices by suppliers. More broadly, econometric analysis identifies a positivecorrelation between concentration and profitability -- but also supports the hypothesis that importcompetition can help discipline highly concentrated domestic markets.'6

16 A regression equation was estimated by Frederick Fourie for this study, with subsector profits as the dependent variable, and theextent of concentration and share of imports by subsector as dependent variables. The sign of the coefficient for the first variablewas positive, and for the second variable negative -- with both coefficients significant at least at the 95% level in a two-sided test.

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The Business Environment/for South Africa 's industriatl SKEs

Table 2K Reasons For Payina More For Inputs

Turning to the impact Than Competitions

of preferential vertical r PFootv>ear Plastic FSumiture Metalexchanges on the operation of I Converters Fixtureinput markets, the ratio of Competitors procure in larger volume

firms which believed that they and/or more consistently than I do 4.3 4.6 4.8 4.2It takes time lor less established rirmis to

pay more for inputs than their build tile relationships which are important

competitors varied widely fbr obtaining reliablc supply at competitive 2.2 2.4 3.5 3.4

across industries, ranging prices.bewenaIo f 4 The suppliers lavor buycrs with ownership or

between a low of 14% familv ties 2.0 2.8 2.8 2.1(furniture) and a high of 67% Trhe supplier is prejudiced against lirms

(metal fixtures). However, as 1.6 1.4 2.0 3.2

Table 28 summarizes, the Number of respondents 12 s 4 20

survey uncovered only modest levidence of preferentialexchanges. The predominant reasons for paying more had to do with volumes purchased and thetime needed to establish business relationships. Note, though, that a significant minority of bothplastics and furniture firms perceived some problems with vertical relations. Note also thatAfrican-owned metal fixtures firms perceived themselves to be discriminated against in thepricing of inputs.

V. SOME IMPLICATIONS

The results on SME constraints in sections III and IV come as something of a surprise.Section III revealed that (industrial relations issues aside) the regulatory framework for SouthAfrica's SMEs is by and large perceived to be benign. Moreover, other than for the smallestAfrican firms, the financial system appears to be quite responsive to SMEs. As for the impact ofindustrial organization, the evidence is unambiguous that South Africa's industrial sector ischaracterized by disproportionately high levels of industrial and conglomerate concentration.This high concentration did appear to add somewhat to the difficulties experienced by smallplastics and metalworking firms in winning work as subcontractors. Further (together withprotectionist trade policy) concentration appears to have resulted in an elevation of the cost ofinputs. Yet, these exceptions aside, the SMEs surveyed did not feel that high concentration hasproduced an unusually difficult business environment for them . In their view, there existsample opportunity to penetrate product markets; inputs are readily available, with little evidenceof discriminatory vertical preferences. Overall, many (though not all) of the markets examined inthis paper are perceived to be highly competitive. Box I evaluates to what extent these resultsapply also to new entrants.

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The Business Environment for South Africa 's Industrial SMEs

Box 1: "But excluded firms cannot be surveyed!?"

A common criticism of enterprise surveys is that they fail to capture the perceptions of entrepeneurs who aredeterred from entry by a difficult business environment. While this methodological criticism of firm surveys istautologically true, in practice --when combined with broader international evidence -- there is good reason to believethat the survey results from existing South African firms indeed offer a reasonably representative picture of theconditions of entry for small firms. To illustrate, this box reviews briefly the financial, market and industrial relations-related obstacles to entry for two types of SMEs.

Take first the example of a very small microenterprise (say, one with fewer than five employees). The surveyresults suggest that such a firm would be unable to attract loan finance at the time of entry. This is indeed an obstacle.but as discussed in the paper one which is consistent with prudent business practice, and is evident the world over. Bycontrast, the results suggest that market-related and industrial relations constraints to entry both would be low. Marketconstraints are low because there exists a very wide variety of market outlets -- individual retailers, flea markets, directsales to consumers -- which complement the market segments dominated by big business. [Note that market constraintscould be severe if overall demand is weak, or if levels of competitiveness are high, quite different points.] As forindustrial relations constraints, the survey results are unequivocal that, without exception, firms with fewer than fiveemployees fall entirely outside the net of formal labor rules.

South Africa's business environment seems somewhat less benign for firms that enter with five or moreemployees. Again, the inability to obtain loan finance at entry mirrors patterns for new entrants worldwide -- however,it is a more disabling constraint for bigger SMEs because their initial financing needs are likely to be quite substantial,and hence less readily met by incremental expansion from a tiny start-up size. [In South Africa, this obstacle is likelyto be especially severe for entrepreneurs from historically disadvantaged communities, who lack the asset base to usetheir own resources for start-up.] For marketing, bigger SMEs are more likely to seek out substantial initial orders, andhence be somewhat more constrained by market concentration -- although the survey results suggest that even for thisgroup, there appears to exist a broad array of attractive, alternative outlets. The industrial relations challenge is likelyto be significant, though, insofar as the survey results suggest that bigger SMEs can expect to be pressured to formalizetheir industrial relations. The process is perceived (by survey respondents, and more broadly in South Africa) to be avolatile one -- with the consequent challenges likely to deter many would-be entrepreneurs from starting up newmedium-sized manufacturing operations.

The roots of high concentration appear to lie in the country's resource and institutionalendowment: in the predominance of deep-level mining, and the large scale organizations whichit spawned; in the decision processes -- where to invest (mineral beneficiation) and where not toinvest (light manufactures) -- that characterize large-scale, mining-based organizations, in theapartheid-era obstacles to the development of labor-intensive businesses in urban areas; in thesystematic underinvestment in human capital for all but a privileged few during the apartheidyears; and in the incentives for mergers and acquisitions that resulted from exchange control, taxand corporate governance laws.

Viewed through the lens of moving South African industry onto an efficient, labor-demanding growth path, the "good news" of a business environment that is only moderatelydistorted is also "bad news". It suggests that there may not be a "quick fix" set of interventionswhich can rapidly and efficiently propel South Africa's SMEs to the forefront of the country'sindustrial transformation. To be sure, it is possible that South Africa's recent politicaltransformation will propel a significant number of South Africans to alter their career choices infavor of starting up a new business. Even so, at the very least the empirical results suggest that inaddition to SMEs, South Africa's policymakers will need to look to other private actors -- topublicly-quoted companies, to foreign investors -- as key movers towards an efficient, outward-oriented and labor-demanding path of industrial development.

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The Business Environment for South Africa 's Industrial SMEs

The research did not, then, uncover the "smoking gun" which has often beenconjectured to constrain SMEs. Rather, the results suggest that deepseated structural patternsaccount for South Africa's high levels of industrial and conglomerate concentration. Many ofthese are legacies of centuries of inequality and discrimination, and will take determined,sustained, multi-year efforts to reverse.

It is beyond the scope of the present paper to layout a comprehensive strategy for SMEdevelopment.'7 Instead, it may be helpful to end this paper by highlighting some carefullymodulated reforms of the business environment which emerge from the research results aspotentially helpful to SMEs, and more generally. [Note that the research did not focus on theinternal organization of SMEs; consequently, it does not offer much insight as to what reformsmight directly enhance enterprise productivity.]

Competition policy.

Even though concentration has not led to generalized market blockages, there is a strongperception of unfair business practices -- especially among the African majority. It is importantfor political as well as economic confidence that the market "playing field" is seen to be level.And to win this credibility, there is a strong prima facie case for strengthening the powers of the(currently toothless) Competition Board. How to do this is a complex issue. Here it must sufficeto note three general points:

* International experience suggests that competition policy can be a useful tool to deterflagrant anti-competitive practices, such as price fixing.

* There continues to be substantial controversy globally as to whether a very large gray areaof busilness practices should be interpreted as anti-competitive in intent, or seen as efficientbusiness practices.* Open-ended comnpetition policy which places vast discretionary power in the hands of anadministrative agency is to be avoided, as it could undermine business confidence and henceprivate investment.

Access tofinance.

It is important on political as well as economic grounds that the difficulties in gainingaccess to finance experienced by the smallest firms (especially the smallest African-ownedfirms) be addressed. Yet, contrary to the widespread view that South Africa's banks neglectsmall firms, the empirical analysis shows that commercial and parastatal banks are active inlending to SMEs. The survey (and other World Bank-supported work which has focused directlyon microenterprises, which generally are in services, and are smaller than the firms which arethe focus of the present study) does suggest, though, there exists a tier of firms to whichconventional banking practices are not well-suited, and that the smallest African-owned firmsmay be subject to some discrimination. For historically disadvantaged borrowers in particular,collateral problems appear especially acute (even though collateral requirements of SouthAfrican banks are relatively liberal by the standards of developing countries).

'7The White Paper on Small, Medium and Microenterprises issued by South Africa's Department of Trade and industry in March,1995 does an eNcellent job in presenting such a strategy.

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The Business Environ7mentforr kSouith Africa 's Indutstrial SMEs

The challenge, then, is not to "reform" a finanicial system which, relative to the standardsof other middle-income developing countries already is reaching many SMEs. Rather, thechallenge is for South Africa's financiers to become global iniovators in enhancing access tofinance by firms which financial institutions the world over find difficult to reach, in ways thatare both prudent and sensitive to the perceptions of discrimination on the part of African firms.

Import and export competition.

The research results highlight the potential gains of some further initiatives with respectto both import and export competition. To begin with import competition, the results suggest thathighly concentrated domestic input markets do indeed raise the costs and reduce thecompetitiveness of SMEs. Yet in many cases (e.g. steel, polymers), high levels of concentrationare the result of large scale economies relative to the size of the domestic market -- a realitywhich aggressive competition policy is powerless to address. The results confirm, however, thatenhancing access to, and reducing the costs of imports, can substantially offset the market powerenjoyed by large domestic suppliers. To enhance national competitiveness, there is thus a strongcase for accelerating import liberalization of inputs used by light manufacturers.

As for export competition, the results suggest that the export efforts and aspirations ofSMEs have remained modest -- and this even in the context of very large export subsidies (i.e.GEIS) and a depressed domestic market. Some new programs to encourage exports (e.g. pre-shipment export finance guarantees, or matching grant programs for market diversification)could be helpful on the margins. However, the results (though perhaps somewhat dated in thisregard given recent changes in trade policy), suggest that firms remain fundamentally committedto an inward focus -- and that it will take more fundamental (and credibly sustainable) changes inthe relative incentives of producing for domestic and export markets to induce them to alter thatview.

Technical and marketing support.

Although the questions of how SMEs might upgrade their technical capability and mightmore effectively work to penetrate export markets have not been examined thus far in this paper,they cannot be neglected entirely. For one thing, SMEs are more dependent than their largercounterparts on the availability outside the firm of technical and marketing resources.Consequently, whether these resources are available is an important measure of how SME-friendly is the business environment. For another, and of more direct relevance here, publicinitiatives can have a valuable positive impact on the supply to SMEs of technical and marketingservices.

Work conducted within South Africa (some supported by the World Bank) has identifieda number of shortcomings in the quality of the technical and marketing support environmentwithin which SMEs operate. First, South Africa's vertical and horizontal networks of inter-firmco-operation are weak -- in part because smaller firms are a relatively unimportant part of thebusiness landscape, in part as a result of the long history of inward-orientation (which tends toresult in a disproportionate emphasis on competition, rather than co-operation among firms), andin part as a consequence of the social and cultural gulfs which divide South Africa's citizenry.

8Note also that the incentives for large business groups to practice "mutual forebearance" will be sharply reduced if industrialstrategy shifts from an inward to an outward orientation.

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The Business Environmenitfor Southt Africa 's Industrial SAlEs

Second, the private marketplace for business services for SMEs also is underdeveloped. On thedemand side, as has been observed elsewhere in the world, SMEs tend to underestimate theusefulness of these services. On the supply side. South Africa's providers of business serviceshave tended disproportionately to focus their efforts on the large firm market. Third, SouthAfrica's SMEs typically do not have financial flexibilitv to invest in the (inherently) uncertainexploration of new markets and technologies; and for all the strengths of the financial system,the provision of risk capital for SMEs remains very limited.

In response to these observed shortcomings. a number of technical and marketinginitiatives presently are in various stages of development and implementation in South Africa --including matching granit funds to support efforts by firms to upgrade their competitiveness, thedevelopment of networks of local service centers and subsectoral technical support centers, andprograms to induce technical professionals (especially in universities and technikons) to offerspecialist technical services to SMEs. The South African officials responsible for developingthese initiatives have done a good job of sorting through the (mixed) international experience,and working to develop programs which experience elsewhere reveals hold the promise ofsuccess. These initiatives warrant continuing encouragement and support.

Uncertainty and industrial relations.

The results highlight the central importance of uncertainty as a deterrent to SMEoperation and expansion. To be sure, the political and economic uncertainties that topped the listof constraints in late 1993 have eased. Yet uncertainties surrounding conflictual industrialrelations ranked quite high even in 1993 -- and, with the easing of the broader uncertainties,presumably loom relatively larger today. For SMEs, as for South Africa's industrial sector morebroadly. it is vital that these workplace conflicts be eased and that the country move as rapidly aspossible towards "win-win" industrial relations. The establishment of NEDLAC, and initiativesto explore the possibilities of incomes and productivity accords, as well as labor marketflexibility for smaller firms, appear to be important steps in the right direction.

Page 28

I