Lecture Note On: Entrepreneurship & Enterprise Development

Chapter Two - Small Business

2.1. Definition and importance
Defining small business is not as easy as it looks: we have different definitions depending on the size of
the industry we are talking about, the purpose of the definition, and the country that the definition is
applicable to. The variables writers use in defining small businesses include: size of working capital,
number of employees, asset size, annual sales, market share, and operational domain. Small business is a
business which employees are few, is owned by one or few individuals, with the exception of the
marketing function has geographically localized operations, and does not dominate its industry.
Worldwide, 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. When we refer to the Ethiopian 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. A business is generally considered small if it is independently owned, operated, and financed;
has few employees; and has relatively little impact on its industry.
For a business to be small, it should meet the following criteria:
 One individual or small group finance the business
 Its operations are geographically localized
 It has relatively small share of the market in which it operates
 It is run by its owners or part owners
 Its management is personalized rather than formal
 The number of employees are fewer than 100
Special Contribution or importance 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. They make exceptional contributions as they
provide new jobs, introduce innovations, stimulate competition, aid big business, and produce goods and
services efficiently.

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 Lecture Note On: Entrepreneurship & Enterprise Development

1. Providing New Jobs

New jobs come from the birth of new firms and their subsequent expansion. 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. The energy, creativity, and innovative abilities of small business
owners have resulted in jobs for other people.
2. Introducing Innovation
Conceivably the strength of small business is their ability to innovate and bring significant changes and
benefits to consumers. The resourcefulness and ingenuity typical of small business have spawned new
industries and contributed a very great many innovative ideas and technological breakthroughs to the
society. As entrepreneurs seek the income and wealth associated with successful innovation, they create
new technologies and products that displace older technologies and products. Small firms produce twice
as many product innovations per employee as large firms do. Small business or individuals working
alone invented, among many things, the personal computer, transistor, radio, photocopying machine, jet
engine, and the instant photograph camera. Small firms also gave us the pocket calculator, power
steering, the automatic transmission, air conditioner, ball-point pen, zipper, and insulin.
3. Stimulating 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, the customer is at their mercy. They may set excessive prices,
withhold technological developments, exclude new competitors, or otherwise abuse their position of
power. But, when in the economy there are many small enterprises, they do their best as far as possible
in providing healthy and constructive competition and there by benefiting the consumers. Small
businesses may compete among themselves in many ways. In order to capture the market, they may
lower the product prices. Or they may improve the quality of products and service offered so as to attract
more customers or grabbing competitor’s customers. As a result, the society, as consumer will benefit
from competition.

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4. Aiding Big Business

The fact that some functions are more expertly performed by small business enables small firms to
contribute to the success of larger ones. If small businesses were suddenly removed from the
contemporary sight, big businesses would find themselves burden with a many of activities that they
could perform only inefficiently.
5. Producing goods and services efficiently
Small firms can outperform large businesses by closely managing operations. Small businesses can
sometimes be more efficient than large businesses, especially in small markets. The continued existence
of small business in a competitive environment is itself evidence of its efficient operations. If small
businesses were hopelessly inefficient and making no useful contribution, they would have been forced
out of business quickly by large businesses.
2.2. Characteristic of Small Scale Industries
1. Closely held: the unit is generally a one-man show. Even if a unit is run by a partnership company,
the activities are mainly carried out by one of the partners and the others are merely sleeping
partners who generally assist in providing finance.
2. Personal character: there is close personal contact/supervision of all activities, say purchase,
production labor, and sale of products. The owner him/herself is generally the manager. Therefore,
these firms are generally managed in a personalized manner. The owner has firsthand knowledge of
whatever is going on in the business. She/he actively participates in all aspects of business decision
making.
3. Limited scale operations: a small scale industrial unit has a lesser gestation/growth/ development
period. A small scale unit has a limited share of a given market. The size of the firm in the industry
is small.
4. Indigenous resources: small-scale industries can be easily located anywhere subject to availability
of raw materials, labor, finance, etc. Small scale units use local resources. Therefore, they have
decentralized or dispersed location.
5. Labor intensive: they are generally more labor oriented with comparatively smaller capital
investment than the large units. The capital investment is limited due to the use of simple
technology. They require large amount of working capital to meet their day-to-day expenses.

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6. Local area of operation: the operations of a small scale unit are generally localized. However,
market for its products need not be local. It may provide to local and regional demands or its
products may even be exported.
7. Simple organization: a small business unit has few or no layers of management. Division of labor
or specialization is low and the resources are limited.
2.3. Small Business Failure factors
Despite the importance of small businesses to the economy, there is no guarantee of small business
success. This failure can be attributed to a lot of factors, which can be generally classified in to two
categories:
A. External factors of failure
Every business is affected by externalities;
 Economic condition /business cycles  Interrupted suppliers
 Fluctuating interest rates  Government regulations
 Interrupted supplies  Labor market trends
 Unstable financial markets  Inflation
Although all businesses /small or big/ are subject to these risks, their effect on small businesses is far
more serious than any other business. This is because the resources a small business owner controls are
very limited which makes it very difficult to deal with these situations.
B. Personal factors of failure
The following can be cited as personal factors attributable to small business failures:
1) Inexperience: too often, entrepreneurs launch their enterprises without having sufficient experience
to succeed. Inexperience can be translated to mean a lack of technical skills of management insight.
2) 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.
3) Mismanagement: humble entrepreneurs steeped in experience can still go under simply
mismanagement of resources; they simply make bad decisions in critical situations.
4) Over investment in fixed asset: when starting or expanding a business, it is tempting to buy
facilities and equipments rather than lease or subcontract. Everyone likes to own assets, but greater
investment on fixed assets means less flexibility to adjust to adverse conditions.

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5) 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.
6) Poor financial control and inadequate record: Many entrepreneurs fail to realize that “income
statement” does mean full picture of “cash flow.”
7) Poor business philosophy: Entrepreneurs may not be fully committed to the long hours required to
make a venture successful.
8) Lack of planning: most entrepreneurs frequently underestimate the importance of planning in
business success. However, not planning means not anticipating future problems and challenges and
not being prepared for them in advance. This surely leads the entrepreneur in to making mistakes
and facing problems which could have been easily avoided though sound planning.
9) Lack of marketing research: in designing of their product negotiating with suppliers, sub-
contracting of its operation – small business must have current market information just like
technological change, price, quality, competitors action
To avoid the above drawback, it is very important to understand the business in depth, developing a
solid business plan, properly manage financial resources, and learn how to manage people effectively.

2.4. Small business Problems in Ethiopia

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 fat limited profit, they search for funds for investment purposes.
Consequently, the approach money lenders who charge high rate of interest hence small enterprises
continue to be financially weak.

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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 materials 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.
Besides, many small business enterprises are suffering with the problem of marketing their products. It
is only by overcoming all these constraints that small enterprises can hope to make their enterprises
successful. Small businesses in Ethiopia face various problems as discussed in detail below.
Product: The business line of small business activities in Ethiopia is relatively similar. Lack of product
diversity, however, is prevalent and as a result similar products are over-crowding the market.
Furthermore, certain small businesses lack the skill to modify their products, such as handicraft
products, pottery, furniture, metal products etc.
Price: Some small businesses sell at break-even or even below cost. Some of the reasons for selling at
such a lower price can be attributed mainly to:
 Lack of basic costing knowledge;
 Salaries or wages of family members involved in production or sales are overlooked as cost
product;
 Not knowing the exact earnings from sales separately;
 During and at the end of the day all family members spend the money earned from sales without
recording;
 Manufacturers do not correctly know how much raw material and accessories are required to
make one unit of a product.
Most small businesses do not know whether they actually make profit or not. They express their success
only by emphasizes the changes they make.
Promotion: Problems related to the promotion of products are listed below:
 Many small businesses plan on promoting their products; however, their budget is mostly tight.
 Even though some enterprises understand that issuing flyers, posters and business cards have
promotional values, they refrain from undertaking such promotional activities to use the money for
other urgent matters.
Retailing: Some small businesses may have the need for retail stores, in order to sell their products, but
do not have the necessary retail outlets. In this case they are obliged to sell products on market days
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only.
Finance: Shortage of funds discourages the smooth operation and development of small businesses.
Even if there are credit facilities, some of the small businesses do not use the money for the intended
purpose. They rather divert it for other unintended and non-productive expenditures. Consequently, the
enterprises fail to return the money back to the lender on time. This can result in a loss of credibility to
get repeated loans when needed most. In order to minimize the impact of shortage of working capital
small businesses should be able to:
 Have a budget/plan on how to use credit funds most effectively and for the intended purpose;
 Have to be able to save money on their own for future investment in their business.
Lack of Market related Knowledge: Due to this aspect being very vital to overcome marketing
problems, the crucial points that small businesses are unable to meet are manifested by:
 Lack of information where the best market areas are located;
 Inability to analyze their respective market;
 Lack of skills to set competitive prices;
 Inability to effectively promote products

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