What is an SME?
Small and Medium Enterprises (SMEs) have become nearly synonymous with entrepreneurial activity and business innovation. Vaunted as the real source of sustainable (at least financially speaking) economic growth, much attention has been lavished by development specialists on these strange creatures, particularly in developing economies. Need I mention the popularity of the term in developed markets, where companies like SAP and Microsoft have “SME divisions”?
But, what is an SME?
According to Wikipedia, an SME is classified by the number of people it employs. What the article doesn’t state is that some institutions use yearly revenues, others go by net profit or by shareholders’ equity. Not only do the metrics change from country to country and among individual programs, but the specific values at which a micro enterprise is considered “small” or “medium” (and thus subject to the special treatment provided by the program in question) or “too big” are also a hot topic of discussion.
I believe that this “convention” (if its wide variability doesn’t belie the use of the term) is a crutch that helps bureaucratic managers justify themselves and their work, but only sometimes helps accomplish objectives – in fact, oftentimes the “definition” of SME hinders the success of most programs by creating a ton of Type I and Type II errors.
Here’s a quick example: consider Craigslist, Inc., a company that employs, as far as I can tell, less than 100 people (according to the Wikipedia entry, 24 souls earn a paycheck there). Clearly an SME, right? Some programs and institutions would say yes, while others, citing its estimated revenue or its ownership structure (eBay owns 25% – don’t get me started on that controversy), would adamantly say no. Who’s right?
It doesn’t matter.
The number of employees only tells you about the challenges that the company faces in the field of human resources, while revenue figures hint at the sales effort and accounting figures may indicate where to find some financial management opportunities. None of these figures give you any real idea of what the company really sees on the ground (but it sure makes it easy for program managers to justify their budgets).
Unlike Craigslist, SMEs in developing markets are beset by a myriad of issues all their own; issues that institutions and specialists try to mitigate or help fledgling companies to overcome. Wouldn’t it make sense, then, to classify SMEs by the issues they face? Wouldn’t “development” efforts become more effective if they could hit their mark with more precision?
Regrettably, as mentioned in a previous post, we don’t have the rich research data that would help us formulate an indisputable taxonomy; however, based on experience, here goes a first draft.
The following guidelines are based on enterprise “life cycle” stages that we have observed throughout Latin America and on the characteristics found in companies in each of the following areas:
- Incorporation
- Accounting procedures
- Documentation
- Management
- Strategy
You may have noticed that these areas are in ascending order from easiest to hardest to diagnose, which coincides, not accidentally, to the degree of importance in the survival and growth of the company.
Small enterprise
More often than not, the small enterprise is managed by the founding entrepreneur with the help of a small staff – this staff is usually mid to low level “worker ants” and very infrequently includes a senior ejecutive.
Incorporation: the company, if at all legally incorporated, is a sole proprietorship; less frequently, it is a limited liability company (in Spanish, Sociedad de Responsabilidad Limitada or SRL).
Accounting: limited to basic bookkeeping for tax purposes (often highly distorted to “optimize” the “fiscal footprint”), small companies usually carry little more than a balanced checkbook – cash flow, after all, requires at least that much.
Documentation: similar to the books, small companies keep only those documents that are required by government officials: powers of attorney, articles of incorporation, tax identity, etc. These are usually out of date. If the company doesn’t need it to do business, it doesn’t exist on the premises.
Management: of the four broad functional skill groups (purchasing, operations, sales, and administration – think Porter’s Value Chain, simplified), the management team’s (if there is more than one manager) experience and or knowledge is limited to one, sometimes two, of these areas, where the most common is operations. The other areas are carried out empirically – which doesn’t necessarily always mean poorly.
Strategy: long-term planning and business vision is usually vague and easily molded by current events. The company’s history is merely a long series of crises that has branded management as “survivors”. This approach doesn’t always lead to failure, and can sometimes contribute to resounding success if the principal entrepreneur is sufficiently astute.
Medium enterprise
Driven by the inherent limits of human management capacity, the founding entrepreneur has found it necessary to hire a couple of executives, sometime these are experienced professionals. Nonetheless, decision making is not normally delegated in any material way.
Incorporation: as many medium companies have several shareholders, the overwhelming majority have incorporated as limited liability companies (SRL, based on a common misconception about liability – another post), but in some cases as NGOs, Cooperatives and Corporations. A notable exception to this is Mexico, where the corporation dominates (aka Sociedad Anónima de Capital Variable or SA de CV).
Accounting: at this size, the company has developed some meaningful accounting data. Many still keep several sets of books and few really leverage the management information that their system contains.
Documentation: having moved up the formality scale, it’s usual to find a more significant archive of legal documents, to include contracts, board minutes, powers of attorney, etc. However, these are drafted from boilerplate and without the assistance of qualified legal counsel. Though this is seldom a big problem given the type of legal system (civil law, see post about put options), mainly because it is easily corrected, it does make for some fun during a due diligence process.
Management: having incorporated other people to the management team, it is usual to see some serious corporate governance issues. Clear symptoms of this are a lack of agreement between an executive’s title (CFO, for instance) and her function (head accountant, for instance), and finding the decision making powers still concentrated in the chief executive (even for the mundane task of signing checks). This is a rich enough area to deserve it’s own post (another post).
Strategy: there begins to be some mid-term planning, if only to get a handle on the company’s operations, however, execution is still near-sighted and reactive. The “business plan” is treated as a necessary gesture to gain access to funding, and infrequently used as a real management tool.
As you can see, using this classification, programs directed at SMEs would be more effective in identifying which companies to work with, and, more importantly, what to do do with them (another post) . Of course, it would require program managers to take a different approach to accomplishing their mission.
