Why Study Small Firms?
It’s June and at FAI we, together with our research partners, are neck deep in data collection for the Small Firm Diaries. As the data come rolling in fast and furious, and questions spawn more questions, we ask each other, frequently in awe, and only sometimes in frustration, how did we get here? Why did we decide to undertake our most complex study yet, recording every transaction of a printer in Bogotá, a carpenter in Nairobi, a shoe maker in Lagos?
It’s a rhetorical question, but it points to the fundamental one underlying the Small Firm Diaries: Why is it so important that we better understand small firms?
Throughout the recent history of development interventions—and the research to support those efforts—the pendulum has swung from big to small. In the 1960s, experts at the UN and the World Bank aimed big, focusing on GDP growth through large capital projects and large scale enterprise development. Disappointing results led to a re-think and a shift in focus by the mid-1970s. Aid agencies, the World Bank, philanthropy started to shift focus away from big infrastructure projects and a focus on “national champions” or import substitution as the path to reducing poverty. You might say there was a shift from macro to micro.
This reorientation towards small set the stage for the microfinance movement. Even without the cooperation of the national government, and even if GDP was stagnant or falling, microcredit could help poor families—in particular poor, rural women—channel their inner entrepreneur and pull themselves out of poverty. As rhetoric, this idea of microfinance was remarkably successful. And proponents of the idea could point to high repayment rates on very small loans to poor, previously excluded populations as evidence towards the conclusion that microenterprises were succeeding, were profitable, and were therefore a good entry point for development policy.
Microloans were helping these business owners, then, not to propel themselves out of poverty, but to get by, to keep on surviving.
Over the next 30 years, research into microfinance revealed a more complex picture. Microenterpreneurs were often eager to take the highly structured loans offered by Mohammed Yunus’ Grameen Bank and the many similar organizations that sprung up in the 1970s and 1980s, and they were often faithful about repaying those loans. It took 20 years or more for reliable studies to show that, despite the rapid growth of microcredit, microbusinesses were not themselves growing. Experimental studies and financial diaries studies helped solve this apparent puzzle, showing that microbusiness owners applied the loans fluidly between household and business needs, wherever they needed a cushion against unexpected or lumpy expenses. Microloans were helping these business owners, then, not to propel themselves out of poverty, but to get by, to keep on surviving. This insight, while perhaps disappointing to those on the perpetual search for a silver bullet, has proven crucial for the providers of financial products and services to poor communities, as it helps them design for the needs of microenterprises as they actually are, not as outsiders might have erroneously assumed them to be.
Meanwhile, a small subset of microenterprises were growing, often quite quickly, and those few, branded as “gazelle” or “gung ho” enterprises or “strivers,” became the focus of many in (and to some extent out of) the microfinance movement. These, the belief was, were the firms that would grow and grow, become more productive, hire more workers and transform economies, all while lifting owners and workers out of poverty.
Once a firm has proven hardy enough to make the jump from a one-woman-shop to a growing concern with a handful of employees, does it have characteristics that make it likely to keep on growing?
Of course, we should all by now know the dangers of linear projections. The fact that some firms do grow rapidly over the course of 1-3 years while a study is following them, does not tell us how long that growth will continue, if at all. Once a firm has proven hardy enough to make the jump from a one-woman-shop to a growing concern with a handful of employees, does it have characteristics that make it likely to keep on growing? Here, the evidence is against the presumption that past growth (from micro to small) predicts future growth (from small to medium). If instead a small business stalls—or even crashes, and dies—is it due to the same obstacles and counterwinds that limit most microenterprises from growing in the first place?
As lessons from the micro experiment warn, failure to understand these businesses risks ill-designed products and programs, unworkable business models, and worst of all poor outcomes for the small firms themselves.
As attention shifts towards the small firms that have made the leap to hire employees, and as providers of business development services seek to serve growing firms at least one notch up from micro (and here we mean the traditional microcredit definition of “micro”—a household-based enterprise with no employees), it becomes more urgent to really understand them. In terms of their aspirations, their goals, and their boundaries, are they more similar to households, or are they more like medium-sized, formal businesses? As lessons from the micro experiment warn, failure to understand these businesses risks ill-designed products and programs, unworkable business models, and worst of all poor outcomes for the small firms themselves.
Reflecting both the importance of small firms as sources of livelihood for their communities, and the acknowledgement that there’s much we still need to understand about these businesses, the Small Firm Diaries is part of a crop of new research that has begun to take on this gap. Our colleagues at CGAP and CFI have also started important new projects to better understand “small firms”, even if we don’t all use the exact same terminology. In fact, we’ll be hosting a webinar this summer to share early findings from the Small Firm Diaries in dialogue with researchers from CGAP and CFI. If you’re not already on the list to hear about FAI events, you can sign up here. Join us!