Chapter two small business

CHAPTER TWO

SMALL BUSINESS: VITAL COMPONENTS OF THE ECONOMY

2.1 Definitions of Micro and Small Enterprise/Small Business

The terms Micro-enterprise and small-enterprise refer in the first place to the size of the business. For a long time,
the concept of ‘informality’ has also used to characterize micro and small enterprise, informality here refers to the
informal nature of the employment process (no contract of employment and low wages) and to the fact that most of
such business are not registered. However for a meaningful classification of firms into categories, the size of firm or
the degree of informality does not provide usable yardsticks. A number of other characteristics of enterprises and of
the entrepreneurs who set up and run them must also be taken into account. At present in most countries, a
combination of the number of workers and invested capital are used as a yardstick.

World wide, individual countries apply their own definitions and criteria in defining categories of small-scale
enterprise. For instance definition applied to micro-enterprise in Ethiopia is different from the developed countries
such as the USA and UK – Attempt is therefore made in this section to cite some of the definitions given to such
categories of enterprise by different countries including Ethiopia.

Micro and Small business enterprise is a specific form of small enterprise. It almost involves businesses with
informal characteristics. Such enterprises usually include small service businesses, bakeries, metal working business,
small furniture maker’s repair and maintenance business, copying business, small scale food production business,
etc… The lower limit in the microenterprise category is the one-person business. The upper limit is often fairly
arbitrarily, drawn at business with a maximum of 10 employees and/or maximum capital of about US Dollar 50,000.
This definition usually refers to the category set by most developed countries. Moreover, studies indicate that this
group (micro-enterprise) provides most jobs in the industrial sector of many developing countries varying from 40%
to 90%.

Generally, there are two approaches to define a small business enterprise. These are: Size criteria and
Economic/control criteria
A. Size Criteria
Though the criteria used to measure the size of business may vary, the following criteria are commonly used to
measure the size of businesses.
i. Sales volume
ii. Number of employees
iii. Insurance in force
iv. Volume of deposits
B. Economic/Control Criteria
The definition of a small business referring to economic/control criteria cover the following:
i. Market share
ii. Independence and
iii. Personalized management

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All of these three characteristics should be satisfied in order for the business firm to be categorized as a small
business. These characteristics are briefly discussed here under.

i. Market share: - The market share of a small firm is not large enough to enable to influence the prices of
national goods sold to any significant extent.
ii. Independence: - The owner of a small business is independent in that he/she has full control over the
business.
iii. Personalized Management: - It is the owner who actively participates in all aspects of the firms’
management and in all major decision making processes. Thus, there is little or no devolution of delegation
of authority.

When we refer to the Ethiopia context, a standard definition to both micro and small enterprise has been set by the
ministry of Trade and Industry study on ‘MSEs development strategy’ which took place on August 1997.
Accordingly, micro enterprises in Ethiopia are defined as those firms with less than ten workforces and with a paid
up capital of not exceeding birr twenty thousand. While the small enterprises are defined as those ventures with less
than ten workforces and with paid up capital of not exceeding birr fifty thousand. The study notes that, over 89
percent of the informal sector operators are concentrated in manufacturing and trade of hotels and restaurants
activities and 85 percent of the small scale enterprise and engaged in manufacturing food fabricated metal furniture
and weaving apparels.
2.2 Economic, Social, and Political aspects of Small Business Enterprise.

Industrialization is of crucial importance to sustainable development. Only very few countries with a small
population and a great wealth of natural resources have succeeded in achieving a high degree of prospects. The
success of a number of newly industrialized countries, especially in East Asia, has emphasized the importance of the
relationship and interaction between agriculture, industry and the service sector. Within each of these sectors
strategic changes are taken place, with employment in agriculture almost always going into sharp decline while
employment in services and the industrial sector grows. Growth in the industrial sector is less rapid than in the
service sector however. In any case the changes referred to highlight the increasing importance of development in the
micro and small enterprise sector.

Developing countries are devoting attention to the development of small scale enterprises in a variety of ways. The
following are the major vital roles that micro and small enterprise can play in the socio-economic development of a
nation.

i. Micro and small enterprises are considered to be greatest value in building up a local production structure
and in promoting economic growth.
ii. Micro and small enterprise are also considered as a means of creating employment opportunity and
achieving a fair distribution of national resource income, knowledge and power.
iii. Small scale enterprises are also seen as a seedbed for the development of local entrepreneurship.
iv. Small enterprises are also important in that can help to promote rural industrialization.
v. Small scale enterprises are also termed or seen as forms enterprises in which more appropriate technology is
applied. They require less capital and more labor. They have the capacity to generate a much higher degree

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of employment with less capital as compared to the large-scale sector. Thus, they are less capital intensive
and more employment oriented.
vi. Small-scale enterprises are also important in that can serve as suppliers of parts and accessories to bigger
industries. This ancillary function involves specialization in specific areas and results in greater profitability.
vii. Small-scale enterprises or industries can also play a prominent role in promoting the export market.

When seen from the individual point of view, going into small business has certain advantages. As a result, the desire
for individuals to own and operate their own small business firm is growing. The following are some of four benefits
that individuals pursuing a career in business ownership can gain according to Scarborough and Zimmerer (1993:10-
112)

(a) Opportunity to gain control over own destiny : Owning a business provides the entrepreneur the
independence and the opportunity to achieve what is personally important.
(b) Opportunity to reach your full potential : Too often, people find their work boring and unchallenging. The
small business therefore, becomes instrument for self expression and self-actualization. In your won
business, all of your skills and abilities will likely be challenged. The only barriers to success are those that
your creativity and determination cannot overcome limits artificiality created by the organization that
employs you.
(c) Opportunity to rap unlimited profits : Although money is not the primary force driving most enterprises
their ability to keep the money their business earn, certainly is a critical factor in their decisions to launch
companies. Without question, men and women who apply their knowledge to produce valuable goods and
services and to solve problems of the society often are rewarded bountifully.
(d) Opportunity to contribute to society and be recognized for your efforts : We no longer can depend solely
on our own skills to provide for all our needs. Entrepreneurs provide the rest of us with goods and services
we need. Small business owners/managers enjoy the recognition from customers when they have served
faithfully over the years.
Being a part of the business system, and knowing that their work has a direct bearing on how the economy
function is another reward for small business owners.

On the other hand, as indicated by Hailay (2003:27) some authorities classify the advantages of owning a small
business into six, namely independence, financial opportunities, community service, job security, family employment
and challenge. These benefits are however, more or less similar to those pointed out by Scarborough and Zimmerer.

2.3 The Potential drawbacks of Small Business Ownership

Although owning a business has many benefits and provides many opportunities, anyone planning to enter the world
of entrepreneurship should be aware of its potential drawbacks. If you aren’t 100 percent sure you want to own a
business’ says one business consultant “there are plenty of demands and this laps along the way to dissuade you’.
The point is that, without proper preparation, an individual may find the career path of business ownership
frustrating. The major potential drawback therefore include, uncertainty of income, risk of losing your entire invested
capital, long hours and hard work, lower quality of life until the business gets established and complete
responsibility.

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i. Uncertainty of income: Opening and running a business provides no guarantee that an entrepreneur will
earn enough money to survive. In the early days of a business the owner often has trouble meeting financial
obligations and may to live on savings.
ii. Risk of losing your entire invested capital : The small business failure rate is relatively high. According to
some research findings 24 percent of new business fail within two years and 51 percent shut down within
four years, within six years 63 percent of new business will have folded. Many of those entrepreneurs who
fail will have lost their personal saving.
iii. Long hours and hard work: New business owners sometime are amazed at the tremendous investment of
time and energy required to get business of the ground. In the start-up phase in particular the entrepreneur
does everything alone-from manufacturing and selling to cleaning and raising money. Studies for instance
show that the majority of new business owners work more than 60 hours per week. In many star-ups, six or
seven day work weeks with no paid vacations may be the norm. When the business closes the revenue stops
and the customers go elsewhere.
iv. Lower quality of life until the business gets established : The long hours and hard work needed to launch a
company can take their role on the remainder of the entrepreneurs’ life. Business owners find their roles as
husbands and wives or fathers and mothers take a back seat to their roles as a company founders.
v. Complete responsibility: It is great to be the boss, but many entrepreneurs find that they must make
decisions on issues about which they are not really knowledgeable. The realization that the decisions they
make are cause of success or failure of the business has devastating effect on some people. Small business
owners realized quickly that they are the business.

2.4 Causes of small Business Failure Factors

Failure can be thrust upon an entrepreneur through external conditions or fabricated by the entrepreneur through
personal short comings.
External factors of failure
Every business is affected by externalities; economic business cycles, fluctuating interest rates interrupted supplies,
labor market trends, inflation.

Personal factors of failure

The following can be cited as personal factors attributable to small business failures:
Inexperience: lack of technical skills and or management acumen. Each of these short comings can be lead to
disaster, but they also can be overcome by individual willing to make the commitment of time and energy to learn
about business.
Arrogance: Many small business persons become consumed with their own brilliance, convinced beyond reason
(often without market research) that their bright ideas will change the world-it has got to sell. Their arrogance will
not allow them to advice from others.
Mismanagement: in experience entrepreneurs simply make bad decisions in critical situations. Several categories of
mismanagement take critical for small business to avoid.

 Over investment in fixed asset in common: When starting or expanding a business, it is tempting to buy
facilities and equipment rather than lease or subcontract.

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 Poor inventory control: This threatens the success of nearly all retail enterprises. Purchasing too much
inventory undermines customer selection and sales. Buying the wrong inventory, or buying at wrong time,
evaporates cash.
 Poor financial control: Many entrepreneurs fail to realize that”income”does not “cash flow.”

Lack of planning: research shows less than half of small business owners had formal plans prior to going in to
business. Many engaged in formal planning soon after starting their businesses, but one third could not recall ever
having a formal business plan. It is nearly impossible to acquire capital, obtains loans or solidifies vendor contracts
without document sales forecasts, financial statements, market analysis and a clear statement the business purpose.
Plans are guide lines for action.

WHAT IS BASIC BUSINESS IDEA?

 It is logical to think of a goal for the unit in long run rather than to look for the immediate tomorrow. This
long-term thinking is called basic business idea.
 The basic business idea and the product through hierarchy can be represented as follows
Basic business idea

Product line

Product range

Product

Figure: Hierarchical presentation of business idea

Business persons should think of long-term goal and the profit when they start a business.

The basic business idea, which is at the top of the hierarchy, is to meet the broadest needs of the customers, and has
the long life perhaps from 5-50 years. The basic business idea facilitates choice of product under an over all plan.
Thus, entrepreneur may think of being in the entertainment firm, in automobiles, in medicines, in services, in
industries, etc.
The product line is relatively narrow and has a shorter life. The product line consists of different families of product.
A unit with a basic business idea for example packaging can metal packages, aluminum packages, paper or wood
packages.
The product range includes different size of the product with in the product line in the examples given above
different size of glass bottles can be manufactured for varied applications.
The product is one item of the product range having different specifications like size, material used and weight, etc.
The basic business idea, which facilitates a choice of the product at different stages of the product, allows for
diversification and expansion. But the basic idea is not always the same. In a dynamic business scheme, one has to
carefully watch is one of the basic idea degenerating as regards.
A. Its ability to generate quick returns
B. Its ability to permit quick changes in the products

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The general business atmosphere guides the choice of basic business idea. A basic business idea results from the
identification of business opportunities in the market.
To be successful in business, consistently watch the opportunities to spot where the entrepreneur has to be sensitive
to the market changes, watch demand and supply, study consumer behavior, and grasp the business idea.

SOURCES OF NEW IDEAS

Some of the more frequently used sources of ideas for new entrepreneurs include consumers, existing companies,
distribution channels, the federal government, and research and development.

1. Consumers: Potential entrepreneurs should pay close attention to the final focal point of the idea for anew
product or service the potential consumer. This attention can take the form of informally monitoring
potential ideas and needs or formally arranging for consumers to have an opportunity to express their
opinions. Care needs to be taken to ensure that the idea or need represents a large enough market to support a
new venture.
2. Existing Companies: Potential entrepreneurs and intrapreneur should also establish a formal method for
monitoring and evaluating competitive products and services on the market. Frequently, this analysis
uncovers ways to improve on these offerings that may result in a new product that has more market appeal.
3. Distribution Channels: Members of the distribution channels are also excellent sources for new ideas
because of their familiarly with the needs of the market. Not only do channel members frequently have
suggestions for completely new product, but they can also help in marketing the entrepreneur’s newly
developed products. One entrepreneur found out salesclerks that the reason his history was not selling was
due to its color. By heeding the suggestion and making the appropriate color changes, his company became
the leading supplier of non brand hosiery in that region.
4. Federal Government: The federal government can be a source of new product ideas in two ways. First, the
files of the Patent Office contain numerous new product possibilities. Although the patents themselves may
not be feasible new product introductions, they can frequently suggest other more marketable product ideas.
Several government agencies and publications are helpful in monitoring patent applications. Second, new
product ideas can come in response to government regulations. For example, the Occupational Safety and
Health Act (OSHA), aimed at eliminating unsafe working conditions in industry, mandated that three people.
The kit has to contain specific items that varied according to the company and the industry. The weather
proofed first-aid kit needed for a construction company had to be different from the one needed by a
company manufacturing facial cream or a company in retail trade. In response to OSHA, both established
and newly formed ventures marketed a wide variety of first-aid kits. One newly formed company, R & H
Safety Sales Company, was successful in developing and selling first-aid kits that allowed companies to
comply with the act.
5. Research and Development: The largest source of new ideas is the entrepreneur’s own “research and
development,” efforts that may endeavor connected with one’s current employment or an informal lab in the
basement or garage. A more formal research and development department is often better equipped and enables the
entrepreneur to conceptualize and develop successful new product ideas.

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METHOD OF GENERATING IDEAS

Even with a wide variety of sources available, coming up with an idea to serve as the basis for a new venture can still
be a difficult problem. The entrepreneur can use several methods to help generate and test new ideas, including focus
groups, brain storming, and problem inventory analysis.
I. Focus Groups: Focus groups have been used for a variety of purposes since the 1950s. A moderator leads a
group of people through an open, in-depth discussion rather than simply asking questions to solicit participant
response. For a new product area, the moderator focuses the discussion of the group in either a directive or a
nondirective manner.
The group of 8 to 14 participants is stimulated by comments from other group members in creatively
conceptualizing and developing a new product idea to fulfill a market need. One company interested in the
women’s slipper market received its new product concept for: a “warm and comfortable slipper that fits like an
old shoe” from a focus group of 12 women from various socioeconomic backgrounds. The concept was
developed into a new product that was a market success. The basis of the advertising message was formed by
comments of focus group members.
In addition to generating new ideas, the focus group is an excellent method for initially screening ideas and
concepts. Using one of several procedures available, the results can be analyzed more quantitatively, making the
focus group a useful method for generating new product ideas. Focus group is groups of individuals providing
information in a structured format.
II. Brainstorming: The brainstorming method for generating new product ideas is based on the fact that people can
be stimulated to greater creativity by meeting with others and participating in organized group experiences.
Although most of the ideas generated from the group have no basis for further development, often a good idea
emerges. This has a greater frequency of occurrence when the brainstorming effort focuses on a specific product
or market area. When using this method, the following four rules should be followed:
1. No criticism is allowed by anyone in the group-no negative comments.
2. Freewheeling is encouraged-the wilder the idea the better
3. Quality of ideas is desired-the greater the number of ideas, the greater the likelihood of the emergence of
useful ideas.
4. Combinations and improvements of ideas are encouraged; ideas of others can be used to produce still
another new idea.
The brainstorming session should be fun, with no one dominating or inhibiting the discussion.
A large commercial bank successfully used brainstorming to develop a journal that would provide quality
information to its industrial clients. The brainstorming among executives focused on the characteristics of the
market, the information content, the frequency of issue, and the promotional value of the journal for the bank.
Brainstorming is a group method for obtaining new ideas and solutions.
III. Problem Inventory Analysis: Problem inventory analysis uses individuals in a manner that is analogous to
focus groups to generate new product ideas. However, instead of generating new ideas themselves, consumers
are provided with a list of problems in a general product category. They are then asked to identify and discuss
products in this category that have the particular problem. This method is often effective since it is easier to
relate known products to suggested problems and arrive at a new product idea than to generate an entirely new
product idea by itself problem inventory analysis can also be used to test a new product idea. Results from
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product inventory analysis must be carefully evaluated as they may not actually reflect a new business
opportunity. Problem inventory analysis is a method for obtaining new ideas and solutions by focusing on
problems.
2.5 Steps in setting a small scale unit.

The following are the major steps in setting small scale unit:
1. Select the right product: the first key to success in any manufacturing activity is to select the right product. In
the beginning, information of possible lines of activity must be obtained, by talking to knowledgeable people, from
industrial publications, or from various organizations.
2. Preparation of detailed project report: This will cover the following aspects:
a) A detailed estimate of demand is to be made-The total demand, existing suppliers and the capacity of existing
units, the demand gap to be met, the customers, the distribution method required have all to be studied.
b) Technical specifications of the process should be carefully studied-the know- how may be available with the
person himself or may be obtained from literature, or from others including government laboratories like the national
laboratories, etc.
c) The equipment required and the sources are to be specified.
d) Requirements of space-land, shed [Link] other utilities like power and water are to be assessed.
e) Man power requirements of direct and indirect personnel are to be determined and their availability ensured.
f) Cost of the project to be worked should be identified.
3. The action phase begins- The form of ownership is to be decided upon and the company formed and registered.
Following this, action directed towards obtaining finance, necessary licenses and necessary infrastructure is to be
taken. This would involve dealing with various government bodies and other institutions like: financial institutions
for finance; sales tax, income tax authorities-for respective registration; licensing authority-for obtaining industrial
license etc.
4. Once all the required authorizations and sanctions have been obtained simultaneous action is to be taken
for the following:
i. Ordering machinery from suppliers.
ii. Obtaining utilities like power and water connections after constructions.
iii. Recruitment of staff.
iv. Arranging supplies of materials.
v. Arranging for distributions of the product.
5. The plant is ready for commissioning.
 Trial run may be made
 Promotional work may be made
On the basis of feed back obtained, the process or product has to be modified until acceptance out put is obtained.
6. The unit is then ready for commercial production.

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