Falling Behind: The Many Challenges Faced by Small Companies in Latin America
Small and medium-size companies comprise between 90% and 98% of all manufacturers in Latin America. They generate about 63% of all jobs, and contribute between 35% and 40% of the region’s total production, according to studies by such institutions as the World Bank, the Inter-American Development Bank and the Economic Commission for Latin America and the Caribbean (ECLAC).
Small companies are active in every sector, from retailing to manufacturing, and even services, healthcare and finance. They are known as SMEs – small and medium-sized enterprises. According to the World Bank, they underpin the social fabric of the entire continent. They are in large cities, medium-sized cities, small towns, and even the most remote villages in the countryside, where they engage in a wide range of agricultural activities.
For all that, SMEs face various challenges to their efficiency, productivity and competitiveness. “There are as many problems as there are companies,” says Jorge Yarce Maya, president of the Latin American Leadership Institute and an international consultant and college professor. “No government devotes a special role to these companies in its social policies – including its laws, regulations and resolutions – and they are falling significantly behind the large companies.”
According to the Bogotá-based Institute, which brings together leaders from Latin America, one of the problems affecting small and medium-sized companies in the region is their role in the underground economy. Jorge Hernán Cárdenas, former dean of the business department at the University of the Andes in Colombia, says that the underground phenomenon affects 50% of all SMEs, ranging from tiny companies that have two or three employees, to small companies (between 10 and 15 employees, depending on the country), and medium-sized companies (that have up to 200 employees).
In Colombia, it’s hard to collect detailed statistics about the underground economy. According to the Foundation for Development and Higher Education (Fedesarrollo), 55% of all companies in Colombia fall into this category. “It may be a higher number because our surveys only have a 63% response rate,” affirms Norman Correa, president of ACOPI, the Colombian association for micro, small and medium-sized companies. The underground economy accounts for 63% of all jobs in the country’s 32 departments and its 1,002 municipalities.
The problem with the underground economy is not simply that there are no processes for registering businesses that can assure banks of their creditworthiness and enable these companies to get business loans. These kinds of companies also fail to get support from institutions and organizations and they lack access to international cooperation agencies, notes the report. In addition, these companies generate poor quality jobs, and shut themselves off from foreign competition.
Hugo Betancur, director of Visión, a business consulting unit at the University of La Sabana, in Colombia, notes that the problem for SMEs is linked to the absence of entrepreneurial management in their top management. One key factor that contributes to their informal [or underground] nature is that many productive units are born out of entrepreneurs’ needs rather than as a result of a planning decision.
In Latin America, the law of the carrot and the stick prevails. In other words, those companies that don’t pay their tax bills on time face the threat of being shut down. According to Julián Domínguez, president of the Chamber of Commerce of Cali, an industrial city in Colombia, people have to get the idea into their heads that you have to pay when you’re legal, and compliance opens opportunities for companies to grow, to become more productive and to compete.
Cristina Rico Carroll, dean of the University of the North, in Barranquilla (Colombia), is an expert at choosing managerial personnel. Carroll warns that during the last 10 years, managers of SMEs have fortunately learned that businesses cannot be administered efficiently without complying with the letter of the law. “Now you can see presidents, vice-presidents and managerial personnel going to the university to prepare themselves and train in managerial and administrative areas,” he says. In the world of academia, they are taught that it is important to enter the formal, legal economy.
Technology that Falls Behind
SMEs also invest comparatively little in technology. And when they do, often they acquire equipment, machinery and software that are inappropriate. Why? “Because, in order to modernize yourself, the first thing you have to do is to focus on the core of the business and only later think about technology,” notes Juan Carlos López, an executive at Neoris, a multinational consulting firm.
Many SMEs ignore the importance of technology and communications, which are indispensable ingredients of any strategy for achieving competitiveness in today’s global economy, notes Germán Andrés Camacho. Camacho manages the Zeiky program at the Sergio Arboleda University [in Bogotá, Colombia], the university’s center for consulting services and information about foreign trade. “The Latin American manager of a small business is generally empirical, and is not in the habit of training himself or permanently staying up-to-date, which is something that is a requirement in today’s information society,” notes Camacho, an expert in finance and foreign trade.
A recent study by FUNDES, a foundation for sustainable development in Latin America, provides some discouraging numbers: SMEs, especially the smallest among them, only invest two percent of their budgets in technology. “Naturally, any company that does not bring its technology up to date is condemned to lag behind in competitiveness and productivity,” states Camacho.
When an entrepreneur thinks about his technology budget, he views it as an expenditure and not as an investment, says Jorge Hernán Cárdenas of the prestigious University of the Andes. “He buys the cheapest thing or simply the least appropriate thing for the focus of his business. And then the results arepoor or at least insufficient,” Cardenas says.
Underdeveloped Human Capital
Nowadays, the new paradigm for management is to get your personnel continuously up to speed with the latest developments by providing training sessions and conferences. In many organizations, employees are known as ‘internal customers.’ That’s another area where SMEs lag behind.
According to Pedro Niño, director of Inalde, the business school at the University of Sabana in Bogotá, the most important thing for companies is not the results they register in the form of profits and losses. Instead, it’s the way they manage their human capital. Juan Carlos Echeverry, professor at the University of the Andes, agrees. “Small and medium-sized companies often lack career planning programs because they don’t have appropriate hiring practices that identify job candidates’ skills, weaknesses, aptitudes and knowledge.” Echeverry supported Colombia’s “Mipyme Law”, which provides institutional support programs for the SME sector.
In most small Latin American companies, the dominant way to get hired is through personal recommendations, notes Andrés Escobar, an economist at the University of Andes and specialist in public administration.
An Obstacle Known as ‘Marketing’
At a recent forum that took place simultaneously in Bogotá and Caracas, the Andean Development Corporation laid out its development strategy for the most vulnerable segment of the population. Experts agreed that SMEs know how to produce things but they don’t know how to sell them. “They have a hard time adopting a marketing strategy in which the focus of the business is the customer; in which markets are segmented, new business opportunities become more visible, and a company moves into new areas,” says Ángela Enríquez, a marketing experience and dean of the Sergio Arboleda University, based in Bogotá.
Generally speaking, managers of small companies view marketing as an expense, not as an investment. So it is hard for their customer base to grow. They don’t create a new supply of goods and services, leaving untapped the great potential in the marketplace.
Without doubt, “the customer is the person who makes any business profitable; it’s not the product,” agrees Martha Lucia Restrepo, who teaches at the University of Rosario in Colombia. “This means that companies depend on markets and on how markets react to the products and services they offer. On the other hand, this doesn’t mean that it is unimportant to have an efficient production process or to manage costs or channels effectively. However, once you’re sure that you have a competitive product, the other part of the job remains in the hands of your customer.”
That’s the case for every company, where it offers goods or services; or is small or large. The big difference is that SMEs don’t apply this approach, says Restrepo.
Restrictions on Loans
No business can possibly exist without having access to credit. However, loans are a scarce resource for SMEs for a variety of reasons: their informal [or underground] nature; the administrative disorder that characterizes some SMEs; their lack of leadership; the absence of real [loan] guarantees; and a shortage of [business] information [about small companies].
According to Jorge Londoño, president of Bancolombia, “The first thing that every micro-enterprise must deal with is how to achieve transparency in its supply of information while maintaining an organized accounting system.” For Londoño, who manages Colombia’s largest financial institution, it is worth the effort to seek out advice about how to diagnose the condition of your business and to implement mechanisms that improve its financial structure.
Several small business associations have been working on a constitution for a Regional Fund for Guarantees for SMEs, but access to credit remains limited for small companies in the region. The Andean Community of Nations -- comprising Peru, Bolivia, Ecuador, Colombia and Venezuela -- has distanced itself from this approach. Although banking has opened itself to this segment of the economy and banks see it as good business, SMEs are punished by higher interest rates and shorter amortization periods because of the way banks assess their risks, notes Norman Correa, president of ACOPI.
The reasoning is simple: Because they are riskier, banks charge them more, as well as cut the time they can take to repay their loans. In many cases, these companies wind up being excluded from traditional financial markets, notes Correa.
Looking to the Future
Despite such challenges, governments, international agencies and multilateral institutions are taking action to promote and assist the SME sector. These efforts will take a long time to bear fruit, Luis Alberto Moreno, president of the Inter-American Development Bank (IDB), stated in his recent presentation on that institution’s new policy for micro-financing.
According to the IDB, SMEs must do a lot of work when it comes to innovation, an area where Chile, Brazil and Mexico are pioneers. They must also work on building partnerships so they can compete globally, and they must create clusters to increase their productivity and competitiveness.
According to the World Bank, the SME sector benefits from the fact that small companies can be more flexible in their response to today’s global changes. Ben Schneider, who developed, promoted and spread the concept of outsourcing, agrees an appropriate business culture for doing that [outsourcing] exists in the region.
From an institutional viewpoint, several support organizations exist in each country, including Sebrae in Brazil and CORFO in Chile; Fomipyme and Expopyme in Colombia; the ministry of small business and development in Argentina; Honduras’s Conapyme and Mexico’s ministry for small and medium-size business.
The IDB has given its Multilateral Investment Fund responsibility for managing several programs that assist the small business sector, with financing, technology, trade, training, innovation and modernization. Various other organizations have become the right arm for SMEs in the region, including the World Bank, the United Nations Industrial Development Organization, the Andean Development Corporation and the Organization for Economic Cooperation and Development (OECD).
Moreno, president of the IDB, notes that its goal is to enable small companies to get involved in the globalization process. Instead of merely subsisting and acting as [ordinary] corporations, they can develop corporate governance policies that enable them to actively participate in Corporate Social Responsibility programs and to take part in the Global Compact (the initiative to encourage businesses worldwide to adopt sustainable and socially responsible policies) that Kofi Annan, then Secretary General of the UN, proposed in 1999.