Enhancing firm performance via distribution channel innovation: The case of small and medium enterprises

Table of contents

Chapter 1 Introduction
1.1. Study backdrop
1.2. Problem statement
1.3. Research questions
1.4. Objectives of the study
1.5. Scope of study
1.6. Contribution & significance of the study
1.7. Organization of the study

Chapter 2 Small & Medium Entreprises in Indonesia
2.1. Summary
2.2. A brief review of Indonesian economic development
2.3. Definition of small and medium enterprises scale in Indonesia
2.4. Development of SMEs in Indonesia
2.5. Evident roles and problems of small and medium enterprises scales (SMEs) in Indonesia
2.6. How to adopt capital access
2.7. A loan proposal
2.8. How to maintain active loan

Chapter 3 Innovation, Distribution Channel, & Firm Performance
3.1. Summary
3.2. Globalization
3.3. The concept of innovations
3.4. The types of innovations
3.5. Distribution channels
3.5.1.The origin of distribution channels
3.5.2. Exchange through intermediaries
3.5.3. Centralized exchange & creating utility
3.5.4. The role & importance of distribution channel
3.5.5. Integration in distribution channel
3.6. Distribution channel institutions
3.7. Distribution channel performance
3.8. Economic firm performance

Chapter 4 Theoretical Framework
4.1. Summary
4.2. Innovation & firm performance
4.3. Product distribution channel & firm performance
4.4. Competitive environment hostility & firm performance
4.5. Distribution channel innovation & distribution channel performance, and hypotheses
4.5.1. Innovation in assortment
4.5.2. Innovation in order processing handling
4.5.3. Innovation in information sharing
4.5.4. Innovation in product and distribution scheduling
4.5.5. Innovation in inventory
4.5.6. Innovation in transportation
4.5.7. Innovation in packaging
4.5.8. Innovation in warehousing & finished good handling
4.5.9. Innovation in acquisition
4.5.10. Distribution effectiveness & firm performance
4.5.11. Distribution efficiency & firm performance
4.5.12. Control variables-Firm size
4.5.13. Control variables-Age of company
4.5.14. Control variables-Competitive environment hostility
4.5.15. Control variables-Industry sector
4.6. Theory
4.6.1. Resources base view
4.6.2. Innovation theory
4.6.3. Transaction cost
4.6.4. Depot theory

Chapter 5 Research Methodology
5.1. Summary
5.2. Data collection & sample
5.3. Quantitative survey
5.4. Survey instrument
5.5. Language and format
5.6. Descriptive variable
5.7. Independent, Dependent, and Mediating Variables
5.8. 5.8.1. Measures of independent variables
5.8.2. Measures of control variables 5.8.3. Measures of mediator-distribution performance
5.8.4. Measures of dependent variable
5.9. Pre testing and Administration of the Actual Survey
5.10. Data Analysis
5.11. Reliability
5.12. Validity
5.13. Assessing the Normality of Data
5.14. Parametric tests
5.15. Conceptual frame work figure

Chapter 6 Empirical Findings and Analysis
6.1. Summary
6.2. Descriptive analysis
6.2.1. Profiles of the respondents
6.2.2. Correlation
6.3. Regression
6.3.1. Multicollinearity
6.3.2. Simple Regression
6.3.3. Multiple Regression
6.3.4 Hierarchical Regression-Distribution effectiveness mediating between innovation in distribution channel and firm performance
6.3.5 Hierarchical Regression-Distribution efficiency mediating between innovation in distribution channel and firm performance
6.4. Plotted coefficient of effectiveness
6.5. Plotted coefficient of efficiency
6.6. Hypotheses testing

Chapter 7 Discussion
7.1. Summary
7.2. Discussion
7.2.1. Innovation in distribution channels & distribution performance in terms of effectiveness of export oriented SMEs manufacturing agricultural based industry in Indonesia.
7.2.2. Innovation in distribution channels & distribution performance in terms of efficiency of export oriented SMEs manufacturing agricultural based industry in Indonesia.
7.2.3. Distribution performance in terms of effectiveness & efficiency as mediators between the relationship of distribution channel innovations & economic firm performance

Chapter 8
Concluding remark, Suggestions for future studies,
Implication of the study & Recommendations
8.1. Concluding remark
8.2. Suggestions for future research works
8.3. Managerial implications
8.4. External factors’ implications
8.5. Recommendations

References

Appendices

App. Results

Attachments

Att.1 Presentation and publications

Chapter 1 INTRODUCTION

1.1. Study backdrop

For many decades, studies conducted on small and medium-sized enterprises (SMEs) have found them to be, by count, the most dominant establishments in the globe. It was found by 2007, Thailand had a total of 2,287,057 enterprises. Of these, 4,292 (0.4%) were categorized as large enterprises (LE) while 2,274,525 (99.5%) were classified under the small and medium-sized enterprises scales (SMEs) category (Nagai, 2007, pp.161-163). In Malaysia, SMEs represent 99.2% of total business establishments (Hashim, 2000 in Shankar, 2010, pp.27-28). In Korea despite the rise and fall in the total number of SMEs over time (1950s up to 1990s), they still averaged well over 80% of the total establishments (Yhee et al., 2001, p.3). And in Indonesia, more than 95% of total establishments are SMEs (Mukhamad Najib et al., 2011). Further more, this is also true for most other countries in the world.

Owing to their establishment supremacy, they would escort positive significant impacts in many economies. In Malaysia alone, SMEs contribute to 32 % of the gross domestic product (GDP), 19% of exports, and 56 % of the employment force; and is expected to contribute even more by the year 2020 (Shankar, 2010). In the United States, SMEs have been converted into a great employment-creating engine. Based on the U.S. Census Bureau (2002), in excess of 100s million of the workforce worked in companies with fewer than 500 workers in 2001. Of these, 10.7% worked in industries with fewer than 10 workers; 18% in industries with fewer than 20 workers; 40,973,082 in industries with less than 100 employees; and 49% in businesses with fewer than 500 employees. In 2001, there were 2,697,839 American companies that employed fewer than 4 workers, contrasted with just 930 that employed more than 10,000 workers (Agyapong, 2010). While in 2009, Indonesian SMEs were able to generate as much as 2,993,151 billion rupiah and shared 56.53 % of the total added value (Mukhamad Najib et al., 2011). This also happened in other neighboring countries such as: Singapore, Taiwan, Thailand, and South Korea. Contributions by SMEs towards employment ranged from 35 % to nearly 61 %, with the contribution to value added ranging between 22% and 40% (Salleh, 1991).

Another contribution by SMEs as private entities is that they are able to take part in reducing poverty through jobs creation. The capital of investment per unit enable SMEs to create more jobs to run business operations whereas in the case of larger firms, a company would only hire few highly skilled employees with high income (Vandenberg, 2006). A study on the role of SMEs in 76 countries by Meghana (2005) also indicated the contribution of the SME sector to both employment and GDP showed a strong positive relationship with GDP per capita. The study found that as countries grew richer, the number of workers in small and medium manufacturing sectors become higher than those in larger sectors.

In recent times, in the globalization era, many SMEs have adopted export-orientation in seeking natural growth, through active participation in the intercontinental market. Scholars suggested that engaging in internationalization may convey advantageous impacts on firm performance. Internationalization also be capable of becoming a major dimension in firms’ growth and allows firms to be more recognizable with the activities of their competitors as well as to afford them better entrée to new market opportunities (Ungson et al., 1997). Furthermore, enhancing the performance of export endlessly contributes to the overall firm’s performance and longevity (Kaleka, 2010). Other ideas recommended by Karagozoglu & Lindell (1998) concerning export-orientation in SMEs is that, it would provide significant impact on firms’ competitiveness in the long term. This due to the global operations orientation will let firms be able to increase new competencies to participate in diverse environments (Vieira, 2009). In macroeconomic dimension, nonetheless, enhancing export performance also has positive significant impacts on GDP/economic growth (Andong Zhu & David, 2011 and Priyanga, 2009).

The crucial role of participating in export for overall SMEs’ performance motivated scholars to search for leading factors that advance export performance. Leonidou (1996), and Zou & Stan (1998) have found that firm characteristics, firm competencies, and marketing strategies become most closely interrelated with the performance of export. Interestingly, Ogbeuhi et al., (1994) has found export failure happens due to the ineffectiveness and inefficiency in the distribution channel’s performance or export activities. Furthermore, Shaoming (1998), in his empirical findings of determinant factors in enhancing the performance of export, asserted that distribution channel contributes to be as one of the determining elements among them.

However, as the characteristic of an established distribution channel is usually difficult to change (Ramaseshan & Patton, 1994) and realizing of the crucial role of distribution channel on firm performance, studies on the relationship among channel members; i.e. suppliers, manufacturers, distributors, and agents, were found to lead to better channel performance. Leonidou (1989); Heide (1994); Morgan & Hunt (1994) recommended that the inappropriate management of relationships between producers and importers could cause malfunction which in turn would affect the operating performance of the firms. Another similar indication showed that conflict among channel members would not strengthen their relationship but rather, reduced the quality of strategy used that could otherwise ease performance. Generally, the driving force of a dealer’s need of maintaining a channel relationship is primarily triggered by the contributions of manufacturers to the dealer’s sales and profits (Frazier et al., 1989). Other several similar topics and findings with reference to channel member relationship could be found in Anderson et al., (1997); Kim (2001); Long (2003); Jennifer (2008); Jiuh (2009); Bret (1995) and Rose & Shoham (2004).

In terms of channel members’ arrangement, Rialp et al., (2002) examined the integration of structural channels over firms in Span that engaged in exporting and invented obvious evidence that establishing linkage to importers via distribution decision can enhance export process. In respects to other channel arrangement studies, Mcnaughton (2002) shared his result-the aim of multiple distribution channel establishment is merely motivated to serve foreign market. Whilst Kumar et al., (2000) suggested, decentralization is recommended as well. Efficient supply chain channel members’ integration may play a more critical role for sustaining competitiveness (Kim,2010). Similiar topics also being addressed by Weigand, (1989, 1991); Ramaseshan & Patton (1994); and Zdenko, (2011) and they were all found to be leading to the performance of channel members.

As innovation is believed designating the main drive for firms to pursue higher competitiveness and better performance, there were findings that have led innovation to remain diverse upon firm performance. Roper et al., (2001); Pla-Barber et al., (2007); Moini (1995); Wagner (2001); Wakelin (1998); Ozçelik et al., (2004); & Galende et al., (2002) found that innovation is closely associated with firm performance, while Mandy (2010) on the other hand, found there to be no significant relationship between innovation and firm performance. Interestingly, Geroski et al., (1993) and Eitan Naveh et al., (2006) indicated the effect of process and administrative innovation lead to different ways with firm performance whilst James Wolff & Pett (2006), on small firms, found process improvement could not explain the growth of sales.

In terms of distribution channel innovation, however, a study by Heide et al., (1994) found the success of an exporter (manufacturer) in a developing country was much associated with how the behavioural relationship with the foreign importer was managed; the use of information technology in distribution channel for instance internet was empirically found to smooth the progress of the internationalization process of SMEs as well as to enhance firms in building the relationship with other distribution channels within the same distribution chain (Fern’andez, 2006). Information technology employed by supply chain members was also indicated to encourage channel member coordination and also have a positive upshot on effectiveness and efficiency. The use of information technology (IT) also directly promotes a precise type of coordination activity in which it would be able to achieve both strategic and operational benefits within the channel (Nada R, 2008). Other empirical studies also have the same indication that using inventory and scheduling integration methods in distribution channels also help to enhance efficiency (Varimna, 2009).

A similar study by Martina et al., (2009) also mentioned that the use of IT may create efficiency in tracking of returnable packaging and transport unit; Product configurators technology which has the capability of customizing a wide range of products, may generate an efficient and effective way of presenting this to customers (Fabricio, 2004). Gunasekaran et al., (2010) in his study on Turkish and Bulgarian SMEs in the food and beverages sector also indicated that implementing IT practices and supply chain strategies in SMEs, would raise the level of competitiveness.

1.2. Problem statement

Realising the importance of distribution channel innovation for firm performance, many studies can be found on these topics. Despite the several case studies, empirical evidences depicting the relationship between innovation (this includes distribution channel innovation) and firm performance are varied. This means that while some studies have shown that innovation is closely associated with firm performance (Pla-Barber & Alegre, 2007 and Moini, 1995; Hirch & Bijaoui,1985; Love, 2001; Ozçelik & Taymaz,2004; Roper & Love, 2002; Wakelin,1998; & so forth), other studies however have found that the effect of process innovation produced different results when associated to firm performance (Geroski & Machin, 1993; Mark,2004; Lin et al., 2007; Eitan, 2006; Mandy, 2010; Gunday et al., 2011 & so forth). Some other studies found that process innovation in the distribution channel did not explain sales growth in smaller firms (James A. Wolff & Pett, 2006). These diverse results are due to the malfunction of past studies in identifying the mediating role of distribution channel performance in the relationship between distribution channel innovation and firm performance.

In terms of distribution channels themselves, each of channel members normally have distribution channel activities which have already been in existence since the time of the ancient Egyptians; the only thing new is the way it is done (Glaskowsky, 1970 and Waidringer & Eng, 2001). The activities’ functions are to guide the product flow from producers to consumers or importers. Most previous studies conducted were on the organizational relationship behavior (Leonidou, 1989; Moore, 1991; Heide, 1994; Morgan & Hunt, 1994; Jennifer, 2008; Jiuh, 2009; Bret, 1995; John, 2006) and governance arrangement among channel members (Weigand, 1989, 1991 & Kim, 2010; Zdenko, 2011; Rialp, 2002; and Mc Naughton, 2002). These studies were found to lead to better channel performance, whilst studies with respect to handling of the goods’ flow (the activities) towards end users in the context of export-oriented SMEs of the agriculture-based industry were extremely limited.

Therefore, to fill the literature gap, besides examining the impacts of innovation in distribution channel performance would in turn enhance firm performance, this study will also attempt to examine the mediating effect of distribution channel performance in terms of effectiveness and efficiency. This is based on the relationship between distribution channel activity innovations and firm performance of export-oriented agricultural-based SMEs.

1.3. Research questions

From the above problem statement and arguments addressed, hence, several research questions have been developed as the following

RQ1: What are the determinant factors of innovation in distribution channel activities that lead positively to firm performance of the export oriented SMEs?

RQ2: What type of innovation affect distribution channel performance?

RQ3: Does distribution channel performance affect firm performance?

RQ4: Does distribution channel performance mediate the relationship between distribution channel innovation and firm performance?

RQ5: How competitive environment hostility affect firm performance?

1.4. Objectives of the study

Motivated by deficient in studies of innovation upon distribution channel activities in the context of SMEs and furthermore being stimulated by diverse findings of innovation including in distribution channel upon firm performance, therefore, to fill the literature gap, the broad objective of this study will be to examine the impact of innovations on product distribution channel on the performance of export oriented SMEs. Several specific objectives derived from general objective are as follows :

Objective 1 : To identify the effect of distribution channel innovation on firm

performance

Objective 2 : To investigate the impact of distribution channel effectiveness on firm performance.

Objective 3 : To investigate the impact of distribution efficiency on firm performance.

Objective 4 : To examine mediating effect of distribution channel effectiveness on the relationship between distribution channel innovation and firm performance.

Objective 5 : To examine mediating effect of distribution channel efficiency on the relationship between distribution channel innovation and firm performance.

Objective 6 : To address the implications of the study

1.5. Scope of the study

This study is focused on internal factors of distribution channel innovation activities of SMEs. To capture how innovation in distribution channel affects firm performance; this study would capture Indonesian SMEs which process raw materials to produce products originating from the agricultural sector. They are export-oriented small and medium scale enterprises in Indonesia and have been involved in the production process, with net assets excluding lands and building less than IDR 200 million and a maximum of 100 employees, most of which are concerned with wooden, handicraft, clothing, and other agricultural-based industries. Innovation in distribution channels will be emphasized on activities wherein agility and responsiveness of human resources between SMEs and other distribution channels’ members are considered similar. The flow of products begins when transactions are completed.

1.6. Contribution and significance of the study

As addressed earlier, the role of distribution channels becomes one of the determining factors for export-oriented SMEs to enhance firm performance in order to gain competitiveness. Studies conducted on governance and behavior among channel members (suppliers, producers, distributors, agents, and consumers) showed an increase in channel performance. At any rate, relevant studies of the producer or manufacturers’ distribution innovation activities in the context of export-oriented agriculture-based SMEs industries were hardly found. Therefore, in terms of knowledge, as mentioned in the literature, by adopting innovation in distribution activities, this study would expect to explain to a certain degree, innovation in distribution channel activities that leads to firm performance, especially in export-oriented agriculture-based SMEs in the manufacturing sector.

The impact of innovation on firm profitability seemed to be positively obvious even though some empirical studies have shown differing results. According to Geroski et al. , (1993), product and production process innovations have a different effect on firm profitability. Hence, for entrepreneurs or stake holders, this study might be giving certain contributions in understanding how innovation in the distribution channel of SMEs leads to firm performance especially in terms of export and how the innovation could strengthen their channel members’ performance. This in turn becomes one of the crucial factors in accessing the international market.

It is commonly believed that the role of SMEs in the global economy is becoming more important and should be considered. As their numbers place them in the highest proportion, hence their abilities to contribute to employment absorbance are highest. SMEs also have a deep impact in adding value to goods and services in almost all sectors. Even, the value added to SMEs has more uniqueness and diversity as compared to the larger enterprises due to the high human resource skill involvement in production. As innovation has become one of the main factors in improving the performance of SMEs, other related institutions such as governments are therefore expected to take part of this responsibility as lack of technology and innovation is still becoming one of the weaknesses holding SMEs back from achieving their competitiveness. This study is likely to give some direction to governments and/or other related institutions in identifying how innovation in distribution channels of the export-oriented agricultural-based SMEs in the industrial and manufacturing sector may enhance firm performance.

1.7. Organization of the study

This study will be organised into eight (8) chapters in order to address and unfold all issues and contents of the study. Chapter 1 begins with common characteristic of SMEs, their definition and contributions to the national and/ or global economy and then continue addressing to series of issues in the topic. To make this chapter easily explicable, the chapter sub section further explain the related issues and an empirical flow of previous findings in respect to the topic in question is then generated. Based on the literature review available, it attempts to state the gap which is coherent with the current issues as well as previous findings from relevant studies. The objective of this chapter is to present how a problem statement briefly emerges and leads to the research questions and objectives of the study, in which it would be expected to enrich the available literature or provide new knowledge. Thereafter, the general picture of SMEs in Indonesia will be addressed in Chapter 2. Chapter 2 describes the view on SMEs in Indonesia; their definition, their contribution to the Indonesian national growth, their characteristics, and the main problems hindering their development. The objective of this chapter (Chapter 2) would be to explain how SMEs in Indonesia, as in other parts of other world, exist, survive and have significant contribution to the economy. Chapter 3 would be focusing on the three main groups of variables involved in the study, namely: innovation, distributional channel, and firm performance. Issues relevant to the three main groups will be addressed in this chapter. Various concepts, theories, and relevant variables are also addressed so as to support the following chapter (chapter 4) in particular, as well as the rest of the study. Another objective of this chapter would be to explain theoretically rather than empirically, of the relevant variables that would support the next following phase of the study. Chapter 4 is the one that shall picture the conceptual framework of the study. The chapter begins with exploring the linkages of each variable involved in this study to distribution and firm performance. In this chapter, all relevant previous empirical findings of the product distribution channel, innovation, distribution performance, firm performance, and other control variables such as environment hostility, firm size, firm age, and industrial sector on firm performance will be addressed. Based on the empirical literature given, the conceptual frame work and hypotheses are built in order to achieve the objectives of the study. The study then continues to chapter 5 which explains the research methodology employed. Chapter 5 describes how the quantitative research methodology, as it is being conducted by other researchers based on the conceptual framework, is conducted to achieve the said objectives. The method of collecting and analysing primary data of SMEs will also be explained accordingly. Some tools of data analysis will also be addressed. Chapter 6 presents analysis and findings obtained through the quantitative procedures in order to go further in the parametric tests. In this chapter, respondents’ profiles and correlation results among the variables will be addressed. These findings would then be used to support certain specific questions and hypotheses posed earlier. Hierarchical regression was also used so as to examine the mediator effect of distribution channel performance between the relationship of distribution innovation and firm performance. Continuing in chapter 7,the authors will revisit the research objectivities and then discuss them in the same chapter. Finally, based on previous discussions, the final conclusion will be drawn with several suggestions of future studies, several implications of the study and research recommendations made and this would constitute chapter 8.

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Chapter 2 SMALL & MEDIUM ENTERPRISES in INDONESIA

2.1. Summary

In this chapter, the definition of SMEs would be addressed, particularly of their contribution to the national economy. Now, as SMEs are generally found throughout countries in the world, their definition would first be compared with the general definition found across other countries before explaining on SMEs in Indonesia itself. Afterwards, the contribution of SMEs to both national and global economies from several points of view would also be presented. As the characteristic of SMEs be at variance from one country to another, the following would highlight the characteristics of SMEs in Indonesia in accordance with Indonesia’s economic potential which generally, are agriculture-based industries. The last part would explain the main constraints for the growth of SMEs in Indonesia and how to be dealing with the constraints.

2.2. A brief review of Indonesian economic development

According to Tulus (2006) in the early years of the new order government of 1966 when a republic Indonesia was led by the former President Soeharto, the average Indonesian was only able to earn approximately USD 50 a year while about 60 % of the adult Indonesian population was unable to either read or write. During that period, approximately 65 % of the country’s population lived in absolute poverty. It was under such circumstances that the five-year economic development plans were launched by the government with the first plan being initiated in 1969. Soeharto also mentioned some crucial economic policies of which some were implemented in the 1970s and others in the 1980s. Other policies implemented were liberalization in investment, capital account, banking and external trade in which industry and agriculture were given the highest level of precedence (Tulus, 2006).

In order to generate the growth of national industries, two successive strategies were adopted. Firstly, from the 1970s up to the 1980s, an import-substitution strategy was implemented which focused on labor-intensive industries such as textile and garments, footwear, wood products as well as food and beverages. This was later followed by automotive assembling industries. Afterwards reducing import tariff and export boundaries became a conducted strategy of export promotion particularly for the labor intensive industries (Tulus, 2006).

Afterwards, the green revolution was adopted in order to enhance agricultural productivity to attain rice self-sufficiency, and enhance real income per capita in rural areas to reduce rural and national poverty as a whole. The result of the strategy had created a fast and sustained economic enlargement at an average of 7 % per year. This was throughout the 1980s all the way to 1997, before the Asian financial crisis which occurred from 1997 to 1998 (Tulus, 2006).

When the Thai government decided to float the Thai Baht in mid-1997, this brought about the financial crisis that spread throughout (contagion effect) the ASEAN countries, which was also known as the Asian financial crisis. The crisis severely depressed the exchange rates of domestic ASEAN and even some East Asian countries as well. By mid-1998 the value of the Indonesian rupiah depreciated to around more than 500 %, the economy of Indonesia grew a minus 13 % and the GDP per capita dropped to less than US$900. This was mainly due to the fact that companies particularly the large-scale enterprises/conglomerates that depended on imported materials and foreign loans halted their production. Later on in 1999 the economy began to recover after reaching a macroeconomic stability, and in 2005 the rate of growth reached 5.5 % while the GDP per capita reached above US$1,000 (Tulus, 2006).

When the price of oil in the world market rose by more than 100 %, the Indonesian government eased fuel subsidies which gave rise to the inflation rate appreciation of October 2005. Due to the sliced fuel subsidy, it was anticipated that the economy’s growth rate would have been less than 6 % in 2006. As the agricultural sector played a dominant role in national industries, the Indonesian economy had undergone a massive structural transformation from an economy that was in its first few years of the new order era (Tulus, 2006).

In comparison, by 1970, the gross value added from the agricultural sector contributed up to 45 % of the arrangement of GDP. During the 1990s, its GDP contribution was only at around 20 % and later declined to about 15 % in 2005. On the other hand, GDP contribution from industrial sectors increased from less than 20 % in the 1970s to almost 30 % in 2005. Industry also joined the big sectors in terms of output growth per year. In 2004, it grew by 6.4 % or 4.6 % in 2005 compared to 2.1 % or 2.5 % in agriculture for the same periods, respectively. By 2005, other sectors that had relatively high growth rates were transport and communication (13 %), trade (8.6 %), construction (7.3 %) and finance (7.1 %) (Tulus, 2006).

2.3. Definition of small and medium enterprises (SMEs) in Indonesia

The definition of Small and Medium Enterprises (SMEs) in general seemed to be multi-dimensional. In Thailand (2002), SMEs in the industrial sector are defined in terms of assets and employee count. For instance, in the manufacturing sector, a small enterprise is defined as one which hires up to 50 workers or with assets of up to 50 million bahts; the wholesale industry defines the same as an enterprise that hires a maximum of 25 workers or with maximum assets 50 million bahts; the retail sector, as one with a maximum of 15 employees or with maximum assets of 30 million bahts; Hence a maximum of 50 employees or with maximum assets 50 million bahts is the limitation set for manufacturing, wholesale and retail enterprises. Also in the manufacturing sector, a medium enterprise comes to be defined as one which hires 51 to 200 employees or with assets ranging from 50 to 200 million bahts; the wholesale industry also defines a medium enterprise with 26 to 200 employees or with assets between 50 to 100 million baths; the service industry defines the same enterprise with 51 to 200 employees or with assets of no less than 50 million bahts and up to 200 million baths. According to European Urban and Regional Studies (2001), micro enterprises are defined as those whose ownership by larger companies be it singly or jointly, does not exceed 25 % and is with less than 10 employees. On the other hand, small enterprises are defined as those whose ownership by larger companies be it singly or jointly, does not exceed 25 % and is with a workforce of 10 to 49 workers. Medium enterprises are those whose ownership by larger companies be it singly or jointly, does not exceed 25 % and is with 50 to 249 employees.

In Malaysia, a small-scale firm defines a company with less than 50 full-time employees and with an annual turnover of not more than RM10 million. A medium-scale enterprise is a company with 51 to 150 employees and having an annual turnover that is between RM10 and RM25 million (Shankar, 2010). In Indonesia, the definition of SMES provided by the Ministry of Cooperatives and Small and Medium Enterprises (Menegkop and UKM), Republic of Indonesia and Central Statistic Agency (BPS). Referring to the Menegkop and UKM Law No. 9 on Small Enterprises of 1995, which defines a small enterprise as a business unit with total initial assets of up to Rp 200 million, excluding land and buildings, or with an annual value of sales of a maximum of Rp 1 billion; and a medium enterprise as a business unit with an annual value of sales of more than Rp 1 billion but less than Rp 50 billion. BPS, which regularly conducts surveys on SMEs, uses the number of workers as the basis for determining the size of an enterprise. In its definition, SMEs are business units with less than 100 employees. Large enterprises are defined as business units with 100 or more workers (Mukhamad Najib et al., 2011).

2.4. Development of SMEs in Indonesia

According to literature, the location of the majority of SMEs, especially for medium enterprises, are widely scattered most being in rural areas. This location characteristic makes them become important as an initial phase for the villagers’ talents development, especially for women entrepreneurs. SMEs which do not hire workers usually operate the business traditionally. They use the family as their labor source which as such leads to low level productivity targeting only the local market. In general, innovation implementation in these groups is very low which makes it difficult for them to survive in the long run especially with import liberalization, changing technology, and the growing demand for higher quality products. Thus, many of these enterprises may in turn show a very slow growth rate. However, the existence or growth of this type of enterprise normally can be seen as an early phase of entrepreneurship development (Tulus, 2007).

As seen in Table 2.1. In the Asia-Pacific region, SMEs are the dominant form of business establishments. Based on the Asia-Pacific Economic Cooperation (APEC) report, it has been shown that about 50 % of total non-agricultural SMEs in the district were in Indonesia and China.

Table 2.1 Numbers of non-agricultural SMEs in selected Asia-Pacific Economies

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Source: APEC (2003) and other official estimated data from individual member economies

(Tulus, 2007).

Referring to Table 2.1 above, if agriculture was included, this portion would surely be much higher as China and Indonesia are known as the largest agrarian economies in the cluster. Distribution by sector showed that SMEs are intense in the agriculture sector (seen in Table 2.2).

Table 2.2 Number of enterprises by size and sector- 2003 and 2004.

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Source: SMEs minister of Indonesia in Tulus (2007).

As seen in Table 2.2. above: trade, hotel and restaurant SME sectors are the second largest sectors for SMEs during the 2003-2004 period after agriculture with around 21 % and slightly more than 22 % of the total units for the period 2003–2004 respectively. The other important sector is the manufacturing industry with around 6.4 % of total SMEs. The SMEs’ activities are mostly involved in simple traditional manufacturing activities such as: handicraft and furniture, clothing, footwear, as well as food and beverages. Only a small share of total SMEs was involved in machineries and tools and automotive components production (Tulus, 2007).

According to Tulus (2000) seen in Table 2.2, as Indonesia’s SMEs are mostly based in agricultural activities, hence most raw materials for the production process would come from the agricultural sectors making them very local intensive and allowing very little room for reliance on imports for their raw material-needing processes, machines and other inputs. In this perspective, Indonesia’s SMEs are expected to have a strong background ability to add value to agricultural and other industries that produce similar inputs. Hence this would promote the development of the agricultural sector and contribute to GDP during the period 2000–2003 in which, almost 95 % of total output of SMEs was from trade, hotel and restaurant, and agriculture sectors (Tulus, 2007).

In terms of the growth, year by year, the new establishment of SMEs tend to be increasing along with their contribution especially in labour and added value. The following tables; 2.3 to 2.5., based on BPS would address the growth of Indonesian SMEs and their contributions.

Table 2.3 The growth of Indonesian SMEs and their contribution for the years 1999 -2002

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Resources: BPS in Najib et al., (2011). * Billion rupiahs

Table 2.4 The growth of Indonesian SMEs and their contribution for the years 2003 -2006

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Resources: BPS in Najib et al., (2011). *Billion rupiahs

Table 2.5 The growth of Indonesian SMEs and their contribution for the years 2007 -2009

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Resources: BPS in Najib et al., (2011).*Billion rupiahs

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Figure 2.1. Value added growth of SMEs 1999 – 2009 in Indonesia

Overall as shown in Tables 2.2-2.5, there are obvious indications that every year new entrepreneurs are born in the country/ society. As seen in Tables 2.1-2.3, it may be concluded that the number of SMEs had reached 52.7 million units by 2009. This means that SMEs are the dominant actors in the Indonesian economy totaling a staggering 99.99 % of the total number of firms in Indonesia. In terms of job creation, SMEs were able to absorb as many as 96,211,332 people in 2009 and cover 97.3 % of the total number of workers in Indonesia. In other words, the majority of employees in Indonesia work in SMEs. In terms of generating added value, Indonesia’s SMEs also contribute to a significant portion. Tables 2.2 - 2.5 showed annual growths of SMEs in terms of added value. The added value of SMEs in 2009 was as much as 2,993,151 billion rupiahs and their shares, 56.53 % of the total added value.

2.5. Evident roles and problems of small and medium enterprises scales (SMEs) in Indonesia

A little flash back to the past history in the Indonesia economic turbulence, when Indonesia was hit by a monetary crisis where its local currency underwent a large devaluation that dramatically increased from 2,500 rupiah to the dollar to above 10,000 rupiah. By 1998 alone, it experienced a gross domestic product (GDP) decline of 13 %. During that period, economists expected the sudden devaluation would increase export activities so that the economy would be able to recover from the crisis. However, it was apparent that the large corporations that dominated the export sector and its activities had yet to lead the country out of the crisis (Jan Ter Wengel & Edgard Rodriguez, 2006). According to Jan Ter Wengel & Edgard Rodriguez (2006), that in 5 years after the crisis, the depressed Indonesian economy did not show any signs of recovery. Furthermore, during 1999-2000 the growth of Indonesia’s economy was still unsatisfactory. In 1999, Indonesia’s GDP grew moderately by less than 1 %. In 2000, the growth reached 4.8 % and then slowed down again to 3.3 % in 2001. A similar growth pattern also occurred in 2002. In fact, poverty figures dropped from 23.4% of the population to 18.2 % in 2002 (World Bank, 2003).

During the period of the crisis, large enterprises (LEs) and small and medium enterprises (SMEs) responded differently to the situation. The capability of Indonesian SMEs surviving from the crisis proved better than larger firms (Berry et al., 2002). One of the reasons why large exporters could not perform well in export was that they mostly depended on a massive amount of imported inputs. Hence, when the rupiah dropped, they also saw their input prices in dollars increased dramatically, making recovery difficult to attain (Zhuang et al., 2001). On the contrary, the crisis gave a rather surprising advantage for SMEs. With a low local market demand and a higher local price for their products, SMEs were forced to find new markets in which many of them switched to international markets. Their low import requirements resisted their competitiveness abroad. The export response of SMEs indicated that small firms are important participants in international trade (Reynolds, 1999). Since then, the role of SMEs in some way came to increase in value and became one of the national economy’s sources of growth.

From the literature addressed, just as in other developing countries, the existence of small and medium enterprises in Indonesia have always played a vital role in contributing to national economic growth. SMEs generally account for more than 95% of all firms in many countries. Referring to the Indonesian Central Bureau of Statistics (2006), there were 48.9 million SMEs in Indonesia and they accounted for around 99.9 % of total business establishments. SMEs in Indonesia have employed 85.4 million people, which is equivalent to 96.18 % of the total number of Indonesian employees. Moreover, the contribution of SMEs to Gross Domestic Product (GDP), excluding oil and gas, is around 53.3 %. The three sectors that employ the most workforces are: agriculture, with 38.8 million workers (43.66%), trading and hotels, with 22.2 million workers (24.98 %), and services, with 9.4 million workers (10.5%) (Ministry of Public Welfare, 2007).

In accordance with Indonesia’s SMEs growth, their dynamic development has been steadily increasing in the various economic sectors since the late 1960s all the way up to 1997. These included both labour intensive products whose competitiveness lay in the country’s low wages as well as other products that relied on natural resources and special policy support. Manufacturing in Indonesia remained dynamic in the 1990s up until the crisis, which began in 1997. Enabling macro and regional economic policies, including the development of financial, trade, and physical infrastructures, contributed to the growth of medium and large industries. In some industries this growth has been at the expense of small enterprise, as in the cases of bamboo weaving and palm sugar processing (Sandee & Rietveld, 2000). In other industries small firms have done well (Hill 1996).

According to World Bank and Albert Berry (2001), it was stated that Indonesia has achieved a strong and widely praised growth and development performance since the late 1960s, that is, until the crisis set in during 1997. The average GDP growth was 6.8 % during the 1970 – 1997 period, with per capita income rising at an average of 4.7 %. Industrialization proceeded rapidly then, with manufacturing output growing at an average of 12.4 % per year, first under an import substituting industrialization (ISI) policy and then, since 1986, under an increasingly open economy strategy. Since 1970, manufacturing rose from 10.3 % of GDP (current prices) to 25 % in 1996, while the employment share of the sector rose from 7.8 % in 1971 (World Bank, 1980, p.122) to 12.6 % in 1996. While average labour productivity in the economy as a whole was rising at about 3.9 %, for the same period that manufacturing was increasing at 7.3%. The role of manufacturing products in total exports shot up dramatically from 4 % in 1984 to 48 % in 1992, with the absolute level (current dollar value) having risen by 8–9 fold from 1.8 billion to 16.1 billion dollars (Hill, 1998).

There have been many studies on SMEs in Indonesia since the late 1960s. As SMEs have important roles in the economy many scholars have been conducting research to examine their several aspects especially for those relating with their performance growth. The study of Tulus (2000) stated that SMEs in Indonesia have a strong linkage with the agricultural sector because the characteristic potential of agriculture in Indonesia is high. Relating with the problems of development, Indonesia’s SMEs are also hampered by various problems which may usually be multi-dimensional relating to capital or finance, raw material, organization management, technical issues, skill (labor), demand (marketing), distribution and many more. All of these problems would likely affect the overall performance of SMEs. In simple terms the level of performance of SMEs is a result of how many problems they may or may not be facing. Not enough up to date information on the opportunities and requirements to access the global market has become a serious constraint facing many SMEs in Indonesia, especially when it comes to meeting international quality standards such as ISO-9000 and ISO-14000. The study also indicated that most of the international marketing was handled entirely through private channels, which is also how SMEs tend to acquire technological capabilities. Unfortunately, such channels are more likely to be ready for SMEs that have well established networks (Tulus, 2000).

Another study conducted by Manginsela. A (2005) indicated that SMEs in Indonesia still faced difficulties in improving their share on export and the country’s GDP. Hence there is a great necessity for the immediate involvement of higher education institutions on the development of SMEs. In the short term, SMEs need assistance on human resources due to lack of management and production skills. Further by Diana Sari et al., (2008) indicated that many young and small SMEs need to address liabilities relating to newness, smallness and inexperience. Many factors should be considered when developing effective and efficient policies and/or programmers for SMEs. Policy makers should have a good understanding of factors that influence the internationalization of SMEs and then prioritize on those areas that require more attention. Policy makers may support SMEs which have ‘internationalization’ potential.

According to Nurul (2007), as some of Indonesia’s SMEs have been diminishing and/or inactive, others on the other hand have been developing and succeeding. In her study, based on a sample size of 100 of SMEs, she indicated that marketing, technology, and capital access have had a positive influence on the success of SME businesses, while legality had the opposite effect. These findings suggested that to be successful, SMEs owners would have to pay closer attention in enhancing marketing strategies, advancing technology, and acquiring capital access. While other parties concerned with the development of SMEs such as government agencies, universities, and other relevant institutions should also be prepared to provide assistance in the field. The exploratory description as to why legality has a negative effect on business success is that there may be difficult official procedures and too many legal aspects that require a lot of SME resources when being dealt with. Simplification of bureaucracy and deregulation of legal aspects are also recommended to foster the development of the SMEs in the Indonesian context.

Other studies relating to distribution conducted by Tulus et al., (2009) indicated several interesting findings. Firstly, in accordance with WTO and ASEAN Free Trade Area (AFTA) agreements, the Indonesian government has been implementing many actual actions so as to improve trade facilitation (TF) which would increase the flow of goods and services both within and outside of the country. However, Indonesia still faces problems with many trade facilitation elements such as: customs procedures, trade regulations, and poor infrastructure that make the process of improvement rather slow.

Secondly, the study also indicated that Indonesian SMEs involved in export activities are generally weak, not only in comparison to their larger counterparts but also to SMEs in well-developed countries. In general, the majority of export-oriented SMEs in Indonesia do not export directly but rather, do so via intermediaries such as; private traders, export companies or trading houses, or through subcontracting agreements with large enterprises (LEs) in which SMEs manufacture semi-finished products which are then finished by the LEs. Thirdly, though empirical evidence is still limited, SMEs, especially those located in rural areas have less access to existing TF as compared to large enterprises (LEs). This is due to their limited capital and knowledge on conducting exports unlike LEs (Tulus et al., 2009).

2.6. How to adopt capital access

One of the main obstacle’s issues for SMEs is facing complicated access for enquiring liquid capital from financial agents-Banking including in Indonesia (Mudrajat, 2003; Manginsela, 2005; Nurul, 2007; Diana, 2008, & Tulus, 2009). Additional capital is required for them (SMEs) to generate tangible and intangible asset be extra productive and competitive. Financial agents both private and state be one of effective supporters for them besides domestic/foreign direct investment. However, in spite of its critical role, the issue of the difficulty remain popular for SMEs throughout the globe. The following issues are derived from the observation in SMEs in Indonesia and Indonesian Financial Institutions. However, based on literature review, observations, and interviews made, most policies discussed would remain similar exclusive of the interest rate.

Literatures found that SMEs still faced difficulties in accessing and adopting financial capital to facilitate their goods’ flow and develop the business. Based on the observation involving regional and national financial agents in Indonesia, the notion of financial capital access difficulties are supposed to broaden further not only in procedural terms, but also in terms of fulfilment. As these days there are many financial institutions in Indonesia be eager to provide various products in support of SMEs, particularly for the export-oriented, hence, this opportunity should be adopted quickly by Indonesian SMEs. Nonetheless, according to Djoni (2010), many of the potential customers were not familiar enough by the banking products, particularly those who inhabit in rural area.

However, in Indonesia, in general, that there were three kinds of loans offered to support SMEs in Indonesia i.e.: loans for consumption, investment, and working capital. However, regarding the types of loan mentioned, to know how to understand their patterns of the calculation, they are classified into several terms namely effective floating, flat, grace period, and R/C (Indonesian conventional Bank, 2011).

Normally, they, all types of loan, may be used for all purposes (consumption, investment, and working capital) as long as the capital flow may be suitable for the Indonesian SMEs. The study found that between flat and effective floating, they had something in common in terms of monthly payment patterns. But in terms of detailed calculations, they were very much poles apart. In general, a flat loan may for instance be calculated based on manual calculations. The following illustration would address how a flat loan was to be calculated in terms of interest and loan. For instance, if customers were to ask for a loan and were granted an amount of $ 10,000 with an annual interest 10% in a period for two years (24 months), the payment calculations would be as follows:

= ($ 10,000 x 10% x 2 (years)) + $ 10,000 + administration fee

24 months

= $ 2,000(interest) + $ 10,000 (loan) + administration fee

24 months

= $12,000 + administration fee

24 months

= $500.00+administration fee/month

Illustration 2.1 Flat monthly payment

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Save a few, most financial agents however, no longer apply such payment patterns simply because, if a customer was able to clear the entire loan before the determined period of 24 months, he/ she would still be required to clear the loan for the entire 24-month period. This form of payment usually becomes a great burden on many customers, particularly for export-oriented SMEs (Indonesian Regional Banking, 2008 & Indonesian Central Bank, 2011).

Another one is effective floating. Unlike a flat payment pattern, effective floating cannot be calculated through manual means. However, to identify the similar result of how much monthly payment is due, it may be calculated by using 1.73 as a special index. For instance, for customers being offered an effective floating rate of 23% annually, we will first need to find the flat rate for loan payment using the following formula:

Interest rate (flat) = interest rate (effective floating)

1.73

= 23%

----------

1.73

Interest rate (flat) = 13.29% per year

After finding the flat interest rate, the same calculation can be conducted in calculating the flat rate.

= ($ 10,000 x 13.29% x 2(years)) + $ 10,000 + administration fee

24 months

= 12,658 + administration fee

24 months

= $ 527.00 + administration fee

Illustration 2.2 effective floating monthly payment.

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Illustration 2.2. above provides a general picture on how effective floating rate is calculated through computerized programming. However, the illustration showed that during the beginning of the period, the loan was large but then began to shrink towards the end of the period. The implication of the illustration is that if customers intend to pay off the entire loan on the 13th month ahead of the 24-month schedule, they need not pay the rest of the interest but should pay the rest of the loan. The following illustration further elaborates

this :

Illustration 2.3 Effective floating monthly payment paid head of scheduled.

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As pictured in the above illustration, the black zone is the area for customers’ payments if they intend to pay the loan ahead of schedule (on the 13th month). Perhaps some additional non-material administration fees would entail additional administration fees (Indonesian conventional Banking, 2011).

Another type of loan is the grace period loan. Unlike the previous ones, a grace period loan would offer different capital flow patterns and perhaps fit better with export-oriented SMEs. Simple calculations may be seen in the following illustration :

Illustration 2.4 Grace period payment schedule (23%/year)

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Source : Author (2011)

As addressed in illustration 2.4 (above), if SMEs was granted a loan of $ 10,000 with a grace period of three months for the loan and every month for the interest, the total monthly payment (interest + loan) starting from January up to December would be similar to illustration(above). The implication of the illustration is that the amount interest would be calculated based on debt balance (5). The lesser the debt balance, the lesser the interest that would be paid. The grace and the year periods are themselves flexible. The grace period may be re-arranged every three, six, or even every one month. It depends on the patterns of SMEs’ capital flows from importers.

Another type of loan is the R/C loan. Calculations made are similar to those done on credit cards. In R/C, the customers are allowed to withdraw the capital as plafond provided while with credit card usage, this cannot be done. For instance: if a customer is granted $ 10,000 as an R/C loan for a period of one year, this means that the SMEs have the right to a benefit of $ 10,000 throughout the year. A good R/C is an active R/C. An active R/C is one with many withdrawals and credits throughout the year. By being active the bank usually, would extend the loan in the following period and may even increase the plafond. The interest of R/C is calculated based on the loan balance withdrawn and is performed on a daily basis, for instance; SMEs withdraw $6,000 as their capital in 20 days. Putting annual interest at 23%, the interest calculation would be (23%/360 days) x 20 days x $ 6,000 =..The principle calculation of R/C is that firstly, as scheduled, SMEs should repay the entire $6,000 loan, together with interest. However, if SMEs have some trouble in repaying the entire loan as scheduled, it may be restructured into monthly payments (effective floating or grace period) for more than 2 years so that the SMEs can pay all obligations. When SMEs have enough capital, they may repay the entire loan one way or the other. Through loan restructuring both SMEs and the banks acquire mutual benefit. For SMEs, they may keep the continued flow of goods whilst for the banks they may still run the business well (Indonesian conventional Banking, 2011).

The types of loans mentioned earlier have a wide set of advantages, particularly for those export-oriented SMEs in enhancing their business. At any rate, SMEs should ensure to derive as much benefit from all of the above products and adjust them accordingly so they may be even more productive. If the capital was only for consumption, there would not be any problems at all to benefit monthly payments such as that of flat, effective floating or grace period. But if export-oriented SMEs need investment for their distribution innovation such as buying more trucks, more containers, more production machinery and so forth, it will be better to benefit grass/grace period in 6 months or a grace period of 6 months in the first year, then after every 3 months in the following year (usually up to 4 years). But also, for those export-oriented SMEs that would like to purchase raw materials so as to enhance their production capacity and enlarge the flow of exports, it would be appropriate to benefit R/C and be active, meaning every month capital should be debited and credited.

2.7. A loan proposal

In terms of arranging the loan proposal, it also needs another innovation so that the proposal would be interesting to see and be examined. Here, the documents should be clean, original as well as being valid. For instance, copies of IDs should not be expired. If what is printed on the ID is not clearly readable, it would be better to attach other supporting documents such as a driving license or family members’ documents. The remainder of documents should also fulfil the above outlined requirements as well.

Any proposal made should clearly state what the capital is intended for, whether it is for business or simply consumption. In general, there are three kinds of proposals, namely: Investment, working capital, and consumption. Working capital is usually for the purchase of more raw as well as other production materials. The loan period would be a 2-year period or less. The following illustration below can be used as guidance on the explicit calculation of working capital.

2.7.1. How to fulfil proposal requirement

Normally, working capital is derived from current assets like: Cash and saving, inventories, gold, etc-short term loans. Unlike large enterprises (LE), the element of SMEs’ balancing sheet is much simpler than that of the large enterprises. The period would be, generally, in 2 years or less. From illustration 10 below, it may be concluded that the amount of working capital of export-oriented SMEs is 33,000.00. If SMEs would like to expand to larger market segment and could increase sales up to 200%, this means that the export-oriented SMEs need to buy more inventories as well as other production factors. However, the ratio of equity to loans should at least be around 60%:40%. It may even be modified as long as customers can fulfil the repayment.

Illustration 2.5.

Customer balancing 1 sheet, …/…/…

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On the other hand, periods of investment will be much longer. Usually it may range between 4 to 5 year periods. For instance, renting and equipped warehousing, purchasing trucks, containers, machineries and so on. When the proposal form has been filled up, it would then require supporting documents. Here, the documents should also be clean and valid; copies of IDs should be valid. If what is printed on the IDs is not clearly legible, better would be to attach other supporting documents such as a driving license or family members’ documents. The rest of the required documents would require similar action.

Composing clear, appropriate, and advanced capital flow for investments would be strongly suggested. The following illustration supported by assumptions would help how capital flow should be arranged particularly for investments. The cash flow below is composed for export-oriented SMEs which intend to innovate their warehousing systems.

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Assumption of illustration 2.6 : SMEs’ warehousing in this context does not have any loan from any financial institution. The innovation as illustrated above, characterizes the export-oriented SMEs’ warehousing. The capital is invested starting from year “0” and then in the same year, equipping all the innovations would also be conducted. A, b and c represent internal income flow from the export-oriented SMEs before being invested. Warehousing activities (f), labour (G) and administrative innovation (h) are the routine costs of SMEs. While letters ‘i’ up to ‘r’, represent the innovation investments from‘d’. And the rest of the investment would be flowing for a final balance. ‘S’ represents other expenses such as: maintenance, security services and others. Sales are expected to increase significantly after investment . EBIT (Earnings before interest and taxes) would be = (e) – (t). EAT (earning after tax) = (u) – (v). EAT would become the final balance. NPV (Net Present Value) would start from the first year as: X * Y and I = 1/ ((1+i=annual interest rate) n). The cost of charity/zakat for each year at a minimum of 2% of NPV would also be necessary.

The cash flow illustration 2.6. is an example how SMEs to prepare investment arrangement for additional capital for financial agents or investors. It is arranged annually and can be assorted into weekly, monthly, semester, annually, and so forth.

2.7.2. Loan feasibility

The studies found that assessing the feasibility of loans is also unique as would be further explained below. Normally, after proposals were examined, loan officers would visit the customers both in the customers’ home and business places. There are several factors that should be considered by export-oriented SMEs during the loan feasibility study. Normally, the loan officers would consider the following (World Bank, 2009; Chong Souk May, 1992; Djoni & Rohman, 2007 and Shri K. Viswanathan & Shri R.R.Borbora, 2011) :

Characte r: In looking at a customer’s character, the main point would be as to how well the customers cooperate with their financial agents. Customers’ participation and response during an interview may be used as a key identification of suitable customers. Being frank, clear, and respectful to each other would be a positive indication to the loan officers. Another aspect of the customer’s character may be examined from the customer’s loans history from previous financial agents. Usually, if the SMEs have been running business for a long period of time, they should have taken loans from other financial agents, and if they are honest they should provide honest information on the loans and payments history from other financial agents. In addition, most loan officers have a sense of distrust when dealing with male customers who would wear gold necklaces. The study however, was not able to find any solid reason behind this distrust. Cleanliness however would be a good indication; a clean business premises, house, warehouse, production process lay out, and so on are all greatly necessary.

Capital: The terms of capital in this context are also broad. Here however, we shall be examining tangible and intangible assets more closely as a source of SMEs’ survival in the global market place. For instance: tangible assets can be examined in terms of current assets and fixed assets. Whilst intangible assets may be measured by things like: the entrepreneurs’ knowledge, managerial skills, innovation, experience, marketing skills, market share, and so on in. These are among the things which financial officers may tend to overlook. However, tangible assets are normally pictured by loan officers starting with the most liquid till the least liquid asset. Cash in savings-in banks or deposit-in banks would also be considered (even though gold is more stable and liquid in value than is cash). The following illustration below would explain briefly how savings records would be read by financial officers: The studies found that assessing the feasibility of loan is also different things. Normally, after the proposals were examined, the loan officers would visit the customers both in customers’ home and business places. There are several factors that should be considered by entrepreneurs during the loan feasibility :

Illustration 2.7. Account of the customer (2011).

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The implication from illustration 2.7 above indicates that the average daily available cash to the customer was (USD/$/RM/Rp/¥/etc) 28,501,477.00. It can be said that the customer was eligible enough to have the loan whether a flat loan, effective loan, grace period loan, or R/C loan.

Capacity: The terms of capacity are equally broad. It is not merely in terms of financial capacity but also in terms of eagerness (intangible asset) to boost the business. However, capacity is usually measured in terms of income which is EBIT (Earnings before interest and tax). This means the result of capacity can be calculated may be calculated from; total sales – total expenses. Total expense would include interest expenses from other financial agents.

Illustration 2.8.

Customer balancing sheet 2, …/…/…

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Illustration 2.9.

Customer income statement from 01/01/… up to 31/01/…

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As shown in illustration 2.9 above, total assets in the period where the loan officer collects data are presented. If the would be customers would not be able to compile such information, the loan officers would usually help them make one. The total assets (tangible) of the customers are normally derived from: Total active assets – total loans (short and long-term loans). The total loans should not be subtracted if the subtraction would mean that the customer would not be left with any assets.

Cash collateral: cash collateral is usually the final consideration of financial agents in assessing the plafond or an outstanding loan. The main factors would character and capacity. But in the end, it all depends on their financial agents and banking policies. Normally, the cash collateral may be on fixed or current assets. Deposit certificates may also be a better choice. The value of cash collateral is usually 80% of the outstanding loan (plafond). For existing customers however, things would perhaps be different.

Condition of economy: The performance of SMEs would always be influenced by both internal and external factors. Empirical studies above have found that innovation in distribution channels can enhance SMEs’ competitiveness which is relevant to the resource-based view theory. Moreover, from the experience obtained from the 1997 financial crisis, inflation has also become a major factor in the growth of SMEs, especially for foreign direct investment (FDI) to the SMEs. Hence, export performance needs to be enhanced in order to balance the supply of demand between the rupiah and foreign currencies, especially the U.S. dollar. The empirical studies found that by innovating the distribution channels of export-oriented SMEs, export performance can be enhanced that may lead to overall firm performance and in turn boost capital inflow of foreign currency that may control overseas debt growth (World Bank, 2009; Chong Souk May, 1992; Djoni & Rohman, 2007 and Shri K. Viswanathan & Shri R.R.Borbora, 2011).

2.8. How to maintain loan

The study found that the 5 C (above principles) principles of assessing loan feasibility were still considered as the initial processes of investment. This means that in that phase, the real capital of export-oriented SMEs are not yet invested. The essence of the assessing is to ascertain that the invested capital will later on be working properly and yield mutual advantageous profits when it is invested. Therefore, when the loan is disbursed, maintain customers become critical for both sides. The objective of this sub-chapter is to present qualitative findings on how to maintain effective floating loan (monthly payment) particularly in export-oriented SMEs in Indonesia.

There are several statuses that should be taken into consideration by SMEs relating to monthly payments of effective loan adoption. Those SMEs that routinely repay debts faster or in time would naturally have a “good status”. Normally, those who maintain such a status would easily be allowed to top up their plafond. Creditors would even allow the SMEs to have a plafond which would exceed the value of the actual cash collateral itself. On the other hand, late payments made more than one month behind schedule are considered as “under special supervision”. Furthermore, if customers disburse the monthly payment later than 3 months, their status would become worse and might end up with cash collateral execution which is the last option by the creditors. This is simply because the status titling mechanism is mostly already computerized hence, the SMEs should always try and adapt to the mechanism in one way or another so that their partnership with the creditors may last for a very long time. It is just the ‘status’ that really matters in these terms. Once the reputation of an SME is not satisfactory, it would be tough to develop further in the subsequent rounds of investing.

Usually, creditors always need to better know the SMEs first before providing them with any loan. This particularly applies for those SMEs whom they have never been acquainted with before. Hence, it is suggested for the SMEs to initiate good relationships with financial agents, just in case an opportunity to expand their business presents itself and they become in need of some capital. The relationship could perhaps be set in motion by requesting a small loan so as to practice how to deal with them. For those existing clients who have a well running partnership, they would normally have easier access to expand the plafond including having a portfolio of various loan accounts.

SMEs that already have an established partnership with financial agents may perhaps face no difficulties in further expanding the loan. However, for those new SMEs who haven’t had any relationships with financial institutions, they would usually be offered monthly payments with effective floating. Under an ordinary business approach, this would be rather difficult hence, innovations would perhaps help.

In terms of effective floating innovation, a good example may be when SMEs need loans for working capital for a 3-month period only. Adopting an R/C loan for new SMEs would most likely be difficult for those trying it for the first time. What SMEs need to do first would be to adopt effective loan payment first. This wouldn’t matter after all. When SMEs can benefit from the capital within three months and are able to repay the entire loan ahead of schedule, then the SMEs need not pay any more interest as seen in illustration 8 (above). After having adopted and familiarised with such type of payment for two or three times, the SMEs can then adopt R/C.

In terms of cash collateral innovation, it is most likely that good SMEs would not have enough guarantees (cash collateral) for loans involving large sums of money. Take for instance the value of land’s certificate being unable to cover the value of an entire loan. The cash collateral may be raised through additional “Deposit certificates and/or savings which may be blocked”. After the SMEs are able to repay the loan in 3, 4 or 5 months time, the value of the main cash collateral (land certificates, vehicles and others) remain the same with the rest of the total loan (loan + interest). The SMEs can then withdraw the deposit or savings certificate for other similar/ same usages.

Table 2.6. International logistic performance index

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World Bank (2007) in Zailani (2010).

Table 2. 7. Comparison logistic infrastructure of countries in ASEAN

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Zailani (2010)

Table 2.8. Studies of SMEs in Indonesia

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Chapter 3

Innovation, Distribution Channel & Firm Performance

3.1. Summary

The chapter would explain the major themes of study i.e. innovation, product distribution channels, distribution channel performance, and firm performance given from the available literature. The aim of this chapter is to present an overall general picture of the themes. Hence, the definition and relevant issues would be highlighted so that the entire themes of the study could be comprehended comprehensively.

3.2. Globalization

David Harvey (2005) defines globalization, in economic point of view, is where the national market barriers for goods, services, capital, labor, and others-tangible and intangible evaporate and all prices are converted into one price-standard. Historically, the first progress of globalization began in nineteenth century when transportation cost occurred. Unfortunately, due to the World War I and an increasing of trade restrictions, it ended up in the early twentieth century. After World War II, governments among countries synchronized international institutions by establishing the World Bank and GATT.

As advocates suggest that internationalization brings many benefits, the study by Heston et al., (2002) in David Harvey, (2005) indicated that countries with GDP have strong correlation with globalization. Countries with lower tariffs opt to have high GDP while the opposite is true for those countries with higher tariffs. Countries with low tariffs might also introduce other reforms. For instance: improving education, reforming institutions, enhancing banking systems, and so forth.

However, empirical evidences relating internationalization and economic growth are obvious. The significant decrease of global trade barriers over the past half century has contributed to the market rise in world trade to GDP ratios (Agarwal 2005). Other similar findings also found that increasing protectionism of individual countries did not trigger growth while on the other hand, some positive cross-sectional correlation existed between tariffs reduction and growth (Solomou 2011). Ponzio, (2005) indicated that Mexico experienced rapid economic growth during the eighteenth century due to exports.

3.3. The concept of innovation

The literatures in general have explained how innovation leads to performance. Nonetheless, several definitions on innovation have been given by scholars in global literature. Urabe (1988) defines innovation as the formation of a new idea and its execution into a new product, process, or service which would lead to the active national economy’s growth, rise of employment as well as lead to profit creation for the innovative profit-oriented organization or firm. Utterback (1994) provides a clearer definition of the innovation concept both in terms of product and process innovation. He defines product innovation as the extension or introduction of new or improved products or services that are successfully accepted in market whilst innovation process involves the implementation of new or improved methods of manufacture, distribution or delivery of service.

However, Hargrave et al., (2006) and Kotler (1991) defined management innovation in separate dimensions. They define management innovation as those activities that engage the preface of changes in management, organization work, and the working conditions and skills of the workforce that can yield better results in effective usage of human and physical resources. Another definition of innovation defined by Damanpour et al., (1989) is a concept which is relating to new or different ways of doing things to fulfil both social and organizational objectives.

Other scholars like Johnson (2001) emphasized the difference between innovation and invention. Invention stressed on the participation of novelties rather than scientific and technological development, such as a new marketing strategy or recruitment policy, whilst innovation does not necessarily involve the creation of novelty but it might be borrowed or learnt from others then adopted or implemented. This is also considered as innovation, as long as it is perceived to be new for the unit of adoption. According to Zaltman et al., (1973), an innovation is: “...any idea, practice, or material artefact perceived to be new by the relevant unit of adoption” (p.10).

Rogers & Shoemaker (1971) stated that “An innovation is an idea, practice, or object perceived as new by the individual. He stated that as long as human behaviour is concerned whether or not an idea is 'objectively' new as measured by the lapse of time since its first use or discovery ...” “If the idea seems to be new and different to the individual, it is an innovation” (Rogers & Shoemaker,1971, p.19). The issue of whether innovation should be approached as a one-dimensional or multi-dimensional model has previously been debated by Cooper (1998) who opinionated that in practice, innovation often occurs in many simultaneous forms. However Venkatraman (1991) defines innovativeness as a personality trait representing an individual’s enjoying for novelties. This approach is preferred over because implementation of novelties is more tangible, more objective, and thus more measurable than an individual's personality. It is also in line with the above definition of innovation by Rogersand Shoemaker (1971) & Zaltman et al., (1973) and many other scholars.

3.4. The types of innovations

The term innovation emerges not only be correlated with products and processes but also related to marketing and organization. According to Oslo (2005) in Gunday (2011), innovation is distinguished into four types: product innovation, process innovation, marketing innovation, and organizational innovation. A product innovation is defined as the introduction of a good or service which is new or significantly enhanced concerning its characteristics or intended uses, including significant improvements in technical specifications, components and materials, incorporated software, user friendliness or other functional characteristics. It can be concluded that either product or process innovations are closely related to the concept of technological developments.

Product innovation itself might make use of new knowledge or technologies, or might refer to combinations of existing knowledge or technologies. The definition of product in these terms would include goods and services. Product innovation is a complicated practice triggered by advancing technologies, altering customer needs, reducing product life cycles and improving international contest. Hence, the firm’s success should involve tough relations within the firm, its customers and suppliers (Akova et al., 1998).

On the other hand, the implementation of a new or significantly enhanced production or delivery method including significant changes in techniques, equipment and/or software is called process innovation. Process innovations can be planned to reduce unit costs of manufacturing or deliverance, to enhance quality, produce or deliver new or significantly enhanced products (Oslo, 2005 in Gunday, 2011).

According to Kotler (1991), marketing innovations are strongly related to pricing strategies, product package design, product placement and promotion activities along the lines of four P’s of marketing. Finally, an organizational innovation is the implementation of a new organizational method in the firm’s business practices, workplace organization or external relations. Organizational innovations have a tendency to increase firm performance by reducing administrative and transaction costs, improving work place satisfaction (and thus labour productivity), gaining access to non-tradable assets (such as non-codified external knowledge) or reducing costs of supplies (OECD, 2005). Examples would be the introduction of practices for codifying knowledge by establishing databases of best practices, lessons learnt and other knowledge, so that they are more easily accessible to others: the introduction of training programs for employee development and improved employee retention or the initiation of a supplier development program. Thus, organizational innovations are strongly related with all the administrative efforts of renewing the organizational routines, procedures, mechanisms, systems, and so forth so as to promote teamwork, information sharing, coordination, collaboration, learning and innovativeness.

3.5. Distribution channel

The word “channel” is a derived French word for canal. The connotation of this meaning in the application is that a pathway engaged by goods as they flow from points of producers to the points of the intermediate and final use. In these flows there is a further connotation of a sequence of marketing agencies namely, the wholesale and retail middlemen who perform type by type and various combinations of marketing functions at various points in the channel in order to facilitate agencies, which perform auxiliary functions at one or more points within the channel (David Revzan, 1967, p.3). Converse (1921) suggested that “the various middlemen who handle an article between the producer and the consumer constitute the trade channel” (p.62). A more complete formulation is offered by Vaile et al., (1952): “A channel of distribution may be thought of combination and sequence of agencies through which one or more of the marketing flows move. Agencies are differentiated from each other according to the combination of flows in which they come into the picture, and the part of the flows for which they take responsibility” (p.121). The distribution channel is also defined as a grouping of intermediaries who take designation to a product during the marketing process from the first point of producer to end customer (Donald Bowersox et al., 1986).

3.5.1. The origin of distribution channels

In general, human culture is characterized by an assortment of goods. The goods assortment’s existence, for instance the assortment of clothing, stocks of foods or fuel, kitchen utensils, and tools, fulfil the needs of individuals either for personal or family use. Every item in the assortment may be considered as a tool or instrument which is designed and made for typical uses. The significance of the good assortments is that they are able to provide facility for various kinds of activities for human beings in which they may expect to engage in (David Revzan, 1967).

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