Entrepreneurship and Small Business

CHAPTER TWO
SMALL BUSINESS: VITAL COMPONENT OF THE ECONOMY

2.1. Definition of Small Business

Specifying any size standard to define small business is necessarily arbitrary, because people
adopt different standards for different purposes. For example, legislators may exclude small
firms from certain regulations and specify ten employees as the cut-off point. Moreover, a
business may be described as “small” when compared to larger firms, but “large” when
compared to smaller ones. For example, most people would classify independently owned
gasoline stations, neighborhood restaurants, and locally owned retail stores as small businesses.

Similarly, most would agree that the major automobile manufacturers are big businesses. And
firms of in between sizes would be classified as large or small on the basis of individual view
points. There are two approaches to define Small Business. They are:
1. By some measure of size.
2. Using an economic/control definition.

In many ways they correspond to a quantitative and a qualitative approach respectively.

1. Size Criteria
Even the criteria used to measure the size of businesses vary. Some criteria are applicable to all
industrial areas, while others are relevant only to certain types of business. Examples of criteria
used to measure size are:
1. Number of employees
2. Sales volume
3. Asset size
4. Insurance in force
5. Volume of deposits.

Although the first criterion listed above- number of employees-is the most widely used yardstick,
the best criterion in any given case depends upon the user’s purpose

SBA Standards
The Small Business Administration (SBA) establishes size standards that determine eligibility
for SBA loans and for special consideration in bidding on government contracts. In 1984, the
SBA issued a revised set of standards, some of which are stated in terms of number of employees
and others of which are stated in terms of sales volume. Some of these standards are shown in
exhibit 1.1

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Exhibit 1.1 examples of SBA size standards

Type of Business Number of Employees or Sales Dollars

Advertising Agencies $3.5 million
Copper Ores Mining 500 employees
Employment Agencies $3.5 million
Furniture Stores $3.5 million
General contractors $17.0 million
Single-Family-Houses $17.0 million
Insurance Agents, Brokers, and Service $3.5 million
Metal Can Manufacturing 1000 employees
Mobil Home Dealers $6.5 million
News paper Publishing and Printing 500 employees
Poultry Dressing Plants 500 employees
Radio and Television Repair Shops $3.5 million
Radio broadcasting $3.5 million

Size standard for most non-manufacturing industries are now expressed in terms of annual
receipts. As it is shown, $3.5 million is a common upper limit in the service and retail areas in
which small business is strong. In mining and manufacturing, however, SBA classifies firms
with fewer than 500 employees as small. To provide a clearer image of the small firms, the
following general criteria for defining a small business are suggested:

a) Financing of the business is supplied by one individual or a small group. Only in a rare case
would the business have more than 15 or 20 owners.
b) Except for its marketing function, the firm’s operations are geographically localized.
c) Compared to the biggest firms in the industry, the business is small.
d) The number of employees in the business is usually fewer than 100.

Obviously, some small firms fail to meet all the above standards. For example a small executive
search firm-a firm that helps corporate clients recruit managers from other organization- may
operate in many sections of the country and there by fail to meet the second criterion.

2. Economic/Control Criteria
The economic/control definition covers:
1. Market Share
2. Independence
3. Personalized Management
All three of these characteristics must be satisfied if the business is to rank as a small business.

1. Market Share
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The characteristics of a small firm’s share of the market are that it is not large enough to enable it
to influence the prices of national quantities of goods sold to any significant extent.

2. Independence
Independence means that the owner has control of the business himself. It therefore rules out
those small subsidiaries which, though in many ways fairly autonomous, nevertheless have to
refer major decisions (e.g. on capital investment) to a higher level of authority

3. Personalized Management
PM is the most characteristic factor of all. It implies that the owner actively participates in all
aspects of the management of the business, and in all major decision-making processes. There is
little devolution or delegation of authority. One person is involved when anything material is
concerned.

2.2 Types of small business

We can have three types of small businesses. These are:

1. Family Enterprises
Are locally owned and operated, often by one person called a sole proprietor. Proprietors may
have started their businesses in an effort to supplement or replace family income. Many are
service-based firms that rely on an owner’s skills. Family owned businesses vary widely and can
include retail stores, contracting businesses, small manufacturing firms, and restaurants among
others. In the absence of a successor, the life of a venture is limited to the working life of its
founder. A florist, for example, may operate successfully until the founder retires, but if no one
exists to succeed the owner, the business is sold or closed. Succession is a serious problem.

2. Personal Service Firms (PSF)

Rely crucially on unique skills of their founders or key employees. In most instances, the
business is the person, and succession is unlikely unless a son or daughter develops comparable
skills. Such diverse occupations as golf professionals, interior designers, and freelance writers
are considered to be PSFs. Since the early 1980s, the premier personal service firm has been the
computer service enterprise that provides: software development, business consulting, office
system networking, and similar assistance to other firms.

3. Franchises
Represent an extraordinary growth sector of the American economy that is spreading overseas at
an accelerated pace. Franchises are created by contract. An individual receives specific help and
advantages in exchange for a franchise fee and, usually, a percentage of sales. The individual
who buys a franchise is called franchisee, and those who sell franchises, the patron corporations,
are called franchisors. The franchisor develops a net work of income-producing enterprises that

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share a common name, use common materials, and sell similar products or services. The
franchisee may receive financial help, training, guaranteed supplies, a protected market, and
technical assistance with matters such as site selection, purchasing, accounting, and operations
management. For example, McDonald.

2.3 Special Contribution of Small Business

As part of the business community, small firms unquestionably contribute to our nation’s
economic welfare. They produce a substantial portion of our total goods and services. Thus,
their general economic contribution is similar to that of big business. Small firms, however,
possess some qualities that make them more than miniature versions of big business
corporations. They make exceptional contributions as they provide new jobs, introduce
innovations, stimulate competition, aid big business, and produce goods and services efficiently.

1. Providing New Jobs

As the population and economy grow, small businesses provide new job opportunities. It seems
clear that small businesses produce the “lion’s share” of the new jobs, sometimes adding jobs
while large corporations are “downsizing” and lying off employees. Between 1980 and 1986,
firms with fewer than 20 employees, accounted for more of the total job growth than did firms of
500 and more employees.

The idea that small business generates more new jobs than big business originated in the
researcher of David L. Birch in the early 1980s. Even though this conclusion has been
controversial, it has received support in some of the more recent research.

Acts and Audretsch, for example, found that 1.3 million new jobs in manufacturing were created
by small firms between 1976 and 1986 while the number of manufacturing jobs in large firms
decreased by 100,000. According to Acts and Audretsch, Birch’s conclusion that the bulk of
new jobs come from small enterprises has been largely substantiated.

2. Introducing Innovation
New products that originate in the research laboratories of big business make a valuable
contribution to our standard of living. There is question, however, as to the relative importance
of big business in achieving the truly significant innovations. The record shows that many
scientific breakthroughs originated with independent inventors and small organizations. Photo
copiers, Insulin, Vacuum tube, Penicillin, Cotton picker, Zipper, Automatic transmission, Jet
engine, Helicopter, Power steering, Color film and Ball-point pen are some examples of new
products created by small firms in the twentieth-century.

It is interesting to note that research departments of big businesses tend to emphasize the
improvement of existing products. Unfortunately, preoccupation with an existing product can
sometimes blind one to the value of a new idea.
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Studies of innovation have shown the greater effectiveness of small firms in research and
development. Innovation contributes to productivity by providing better products and better
methods of production. The large number of small firms that provide the centers of initiative and
sources of innovation are thus in a position to help improve a country’s productivity.

3. Stimulating Economic Competition

Many economists, beginning with Adam Smith, have expounded the values inherent in
economic-competition. In a competitive business situation, individuals are driven by self-
interest to act in a socially desirable manner. Competition acts as the regulator that transforms
their selfishness into service

When producers consist of only a few big businesses, however, the customer is at their mercy.
They may set high prices, withhold technological developments, exclude new competitors or
otherwise abuse their position of power. If completion is to have a “cutting edge” there is need
for small firms.

The fall of communist governments in Easter Europe and the breakup of the USSR made
possible a return to a competitive economic system there. Communism’s economic system,
lacking a free market and business competition, was a dismal failure. Scrapping that system of
state-owned enterprise opened the way for independent business firms, many of them small
firms, to compete and thereby to increase productivity and raise the standard of living.

Even China has taken steps to encourage the formation of small businesses as a means of
stimulating economic growth. As China’s leaders have recently introduced elements of
capitalism, including privately owned businesses, the country has experienced a dramatic rise in
living standards.

The existence of many healthy small businesses in an industry may be viewed as desirable.

4. Aiding Big Business

The fact that some functions are more expertly preformed by small business enables small firms
to contribute to the success of larger ones. If small businesses were suddenly removed from the
contemporary scene, big businesses would find themselves saddled with a myriad of activities
that they could perform only inefficiently. Two functions that small businesses can often
perform more efficiently than big businesses are the distribution and the supply function.

i. Distribution function
Few large manufacturers find it desirable to own wholesale and retail outlets. Think, for
example, of products like toiletries, books, lawnmowers (machine for cutting glasses), musical
instruments, gasoline, food items, personal computers, office supplies, clothing, kitchen
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appliances, automobiles, tires, auto parts, furniture and industrial supplies. Wholesale and retail
establishments, many of them small, perform a valuable economic service by linking customers
and producers of these products.
ii. Supply function
Small businesses act as suppliers and subcontractors for large firms. Large firms recognize the
growing importance of their suppliers by using terms like “partnership” and “strategic alliance”
to describe the ideal working relationship.

In addition to supplying services directly to large corporations, small firms provide services to
customers of big business. For example, they service automobiles, repair appliances and clean
carpets produced by large manufacturers.

5. Producing goods and services efficiently

Common sense tells us that the efficient size of business varies with the industry. We can easily
recognize, for example, that big business is better in manufacturing automobiles but that small
business is better in repairing them.

The continued existence of small business in a competitive economic system is in itself evidence
of efficient small-business operation. If small firms were hopelessly inefficient and making no
useful contribution, they would be forced out of business quickly by stronger competitors.

Although research has identified some cost advantages for small firms over big businesses, the
economic evidence related to firm size and productivity is limited. The following summary
points out some of the reasons for the relative strength of small business.

New contributions to the theory of business organization and operation suggest that firms are less
encumbered by the complex, multi-echelon decision making structures that inhibit the flexibility
and productivity of many large firms. Because the owners of small firms are often also their
managers, small firms are less likely to be affected adversely by the separation of owners’
interest from managerial control. Empirical evidence of small firm survival and productivity
suggests that, where firm size is concerned, bigger is not necessarily better.

We believe that small business contributes in a substantial way to the economic welfare of our
society.

2.4. Economic, Social and Political Aspects of Small Business Enterprises in Ethiopia
Small businesses (enterprises) have to play a vital role in Ethiopian economy. They need a
strong support on socio-economic and political grounds.

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Socialistic Idea
Our goal is being the establishment of a socialistic pattern of society. Our objectives are
equitable distribution of wealth and decentralization of economic power. The benefits of
industrial growth should be shared by as many people as possible and should improve the
general standard of living. Proliferation of small enterprises will go a long way in achieving
these objectives.
The state of Ethiopia where there is a large network of small scale enterprises, with
comparatively less investments in the large scale sector, the general standard of living is much
higher than in the states where heavy investments have been made in large scale industries.

Less Capital and More Labor

The main problem is that we have vast manpower but inadequate capital, which has resulted in
increasing unemployment. This is unlike in situation in western countries where manpower is
limited but capital resources are enormous. Planners have realized the necessity of encouraging
small industries because they require less capital but generate more employment. It is estimated
that through the net-out per worker in large and medium industries is more than twice as
compared to that in small scale industries, the investment of capital per worker is about seven
times.

The small-scale sector has the capacity to generate a much higher degree of employment than
the large-scale sector. For example according to the data collected by the development
commissioner of small industries states that-the fixed investment in plant and machinery per
worker in the small-scale sector is about Rs. 3000 and it is Rs. 20,000 in the large scale sector.
The present inflationary trend is largely due to shortage of goods. More production needs more
capital in such a situation. The small industries will stand in good position because they are less
capital intensive and more employment oriented.

Removing Regional Imbalance

Another problem is the continues shifting of people from rural to urban areas which causes over-
crowding in cities with slum conditions due to lack of social and medical amenities which
require heavy investments. This problem can be solved by inducing people to set up small
industries in rural areas.

The prolific setting up of agro-based industries will go a long way in creating a balance in our
country’s economy.

Creating Self Employment Opportunities

In India, since independence it has had a steady rise in the number of qualified engineers seeking
suitable jobs. But having in adequate avenues, they can have self-employment by settings up
small industries with the help and expertise provided by the government and other agencies.
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Main bank and several industrial corporations, here, have arranged special training programs for
young entrepreneurs, who can easily set up their own units with package assistance from the
governments.

Ancillary Function
Many small-scale industries units supply parts and accessories to bigger industries. This
ancillary function involves specialization in specific areas and results in greater profitability.
The government has, therefore, relaxed the ceiling of investment in plant and machinery for
ancillary unit.

Export Promotion
Small-scale industries have also opened up fresh avenues in the export market. Realizing the
importance of the small-scale sector in the economy the government has adopted several
measures to speed up the growth for small industries.

Supply of Critical Raw Materials

The government has also liberalized the import policy to ensure regular supply of raw materials
to small industrial units, and devised a more efficient and consistent system of distribution of
critical raw material

Problems in Ethiopian Small Business

Small-scale industries have not been able to contribute substantially as needed to the economic
development particularly because of –financial, production, and marketing problems. These
problems are still major handicaps to their development. Lack of adequate finance and credit has
always been a major problem of Ethiopian small business. Small-scale units do not have easy
access to the capital market because they mostly organized on proprietary partnership basis and
are of very small size. They do not have access to industrial sources of finance partly because of
their size and partly because of the fact that their surpluses which can be utilized to repay loans
are negligible. Because of their size and partly because of the fact limited profit, they search for
funds for investment purposes. Consequently, the approach moneylenders who charge high rate
of interest hence small enterprises continue to be financially weak.

Small-scale enterprises find it difficult to get raw materials of good quality and at cheaper rates
in the field of production. Very often they do not get raw material in time. As a result, these
enterprises very often fail to produce goods in requisite quantities and of good quality of a low
cost. Furthermore, the techniques of production, which these enterprises have adopted, are
usually outdated. Because of their poor financial position they are not able to buy new equipment
consequently their productivity suffers.

Many small business enterprises are suffering with the problem of marketing their products.

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It is only by overcoming all these constraints that small entrepreneurs can hope to make their
enterprises successful.

Management Practice in Ethiopian Small Business

Small-scale industries sector occupies a strategic position of unique importance in the Ethiopian
economy. Today, the village and small-scale industries sector roughly account for roughly
about one-half of the total industrial production. Industrial relations is not a major problem in
Ethiopian small business and job specialization is not strictly adhered to by them, life time
employment may not be possible in Ethiopian small business because of limited scope they offer
for career growth of employees.

What is more important in the Ethiopian business environment is to change the attitude of work
force, make them disciplined and duty conscious, and inculcate in them a sense of commitment
towards their organization.