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The Importance of Small- and Medium-sized Enterprises in Russia in relation to the other BRIC countries

Diploma Thesis 2014 145 Pages

Economics - International Economic Relations

Excerpt

Table of Content

Introduction

Literature Review

1. BRIC Countries
1.1 Definition BRIC
1.2 Emerging Markets
1.3 Method of Selecting BRIC Countries
1.4 BRICs or BRICS?
1.5 Macroeconomic Environment

2. Small- and Medium-sized Enterprises (SMEs)
2.1 Definition and Classification of SMEs
2.2 Importance of SMEs
2.2.1 Technology Changer
2.2.2 Economy Stimulator
2.2.3 Niche Marketer
2.2.4 Job Generator
2.3 Entrepreneurial Motivations
2.4 Barriers in SME Development
2.5 SMEs in Brazil, India and China compared to SMEs in Russia
2.5.1 History of Russia’s SME Tradition
2.5.2 Critical Issues hampering Russia’s SME Growth Potential
2.5.3 Business Reforms in Russia

3. Research Question

Empirical Study

4. Contingency Theory
4.1 Definition and Classification
4.2 Various Approaches

5. PESTEL Analysis

6. Research Methodology
6.1 Data Collection and Sample Selection

7. Findings
7.1 Pre-foundation Period
7.1.1 Motivators
7.1.2 Opportunities
7.1.3 Threats
7.1.4 General Attitude of Russians towards Self-employment
7.1.5 Summary
7.2 Foundation
7.2.1 Location decision
7.2.2 Problems faced by the Founders during the Foundation
7.2.3 Time, Money, and Efforts required for the Foundation of the Company
7.2.4 Assistance by Government or other Institutions
7.2.5 Summary
7.3 Barriers to a Sustainable SME Sector Growth
7.3.1 Perceived Factors hindering SME Growth in Russia
7.3.2 Current problems faced by the participants’ companies
7.3.3 Simplification measures set by the government over the years
7.3.4 Summary
7.4 Future Outlook
7.4.1 Expected simplification measures
7.4.2 Growth plans
7.4.3 Summary
7.5 Results from the PESTEL Analysis

8. Conclusions and Further Research
8.1 Conclusion
8.2 Limitations
8.3 Further Research

References

Appendices

Appendix A: Interview Guideline

Appendix B: Final Template (codes)

List of Figures

Figure 1: Company types according to their level of research and engineering capabilities

Figure 2: Two-dimensional plot of SMEs according to their innovative capacity .

Figure 3: Motivators for Russian entrepreneurs to start a business

Figure 4: Results for the Russian Federation on Doing Business Report 2014 ..

Figure 5: Development of the number of SMEs in Russia

Figure 6: Russian experts’ assessment of factors inhibiting and facilitating the development of entrepreneurship in 2011

Figure 7: Most effective state-support measures to enhance SME growth in Russia

Figure 8: Corruption Perceptions Index (CPI) in the BRICs

Figure 9: Bribe Payers Index (BPI) in the BRICs

Figure 10: Domestic credit to private sector (% of GDP) in the BRICs

Figure 11: Lending interest rate (%) in the BRICs

Figure 12: Nominal interest rates drawn by Russian SME in 2007

Figure 13: State budget expenses on SME support program

Figure 14: Key measures on the SME development undertaken by the Russian Government in 2010

Figure 15: Layers of the business environment

List of Tables

Table 1: The Paradigm Shift of International Business

Table 2: Frequently used criteria for defining Emerging Markets

Table 3: Classification of the Emerging Markets

Table 4: Factsheet BRICs

Table 5: Definition of SME by the European Commission

Table 6: Definition of SME in Russia

Table 7: Crucial practices to ease doing business for SMEs

Table 8: PESTEL analysis

Table 9: Research participants and their companies’ basic information

Table 10: PESTEL analysis findings

Table 11: Special negative influencers on SME growth in Russia

Abstract

This diploma thesis provides an overview of the contemporary debate about the importance of small and medium-sized enterprises (SMEs) in the BRIC countries with a special focus on Russia. Conclusions are based on historical perspectives showing that there are huge country-specific divergences and concepts of supporting SMEs. In contrast to multi-national corporations (MNCs), which are not uncommonly supported by the government of the fast-developing country they stem from respectively they are entering and can continue their triumph easily, SMEs often face tremendous difficulties to establish themselves. While the engine of the economy of industrialized countries are SMEs, it seems as if BRICs, especially Russia, struggle to provide appropriate incentives for the foundation of domestic SMEs in order to boost the economic driving force which interviews.

Acknowledgements

First of all, I would thank my supervisor, a. Univ.Prof.in Dr.in Erna Szabo MBA, who has been very supportive since the beginning of the thesis, giving me constructive feedback throughout the entire writing process.

Special thanks go to all my interviewees, who gave interesting insights into their business and as a result provided constructive input to the thesis. Without them it would not have been possible to do an empirical research.

Furthermore, I would like to thank my friends and family who have always encouraged me and listened to me when I needed them.

Introduction

Since the persistent process of globalization in the 21th century the world has become cross-linked as never before, especially because of groundbreaking developments in the information and communication technology and the transportation sector (Greve, 2000). Defined as “The deepening intertwining of all global economy activity ” as Goldstone (2012, p. 2) explained, the term globalization has had a remarkable impact on the choice of production and location of a firm (European Commission, 2012). Greve (2000) furthermore claims that multinational corporations (MNCs) have achieved big advantages acting globally or at least internationally, such as technology, education, finance and management (Zhang & London, 2011) a long time ago and could increase their revenues and profitability.

Although developed countries are said to benefit much more from the effects of globalization than developing nations do (Zhang & London, 2011), there are a few emerging market countries, which definitely profited enormously from the opportunities of globalization - the BRICs (Goldstone, 2012). The reason for the particular importance of Brazil, Russia, India and China (BRIC) is that as distinguished from other emerging markets these countries reported an outstanding growth of their economic weight (Wilson et al., 2011).

Nevertheless, Goldstone (2012) claimed that these four leading economies of the world’s emerging regions seem to fall short of the expectations for the same reason they initially were praised to the skies - globalization. He further elucidated that different from the U.S. and Europe during their triumphal economic procession in the 19th and early 20th centuries, the BRIC countries did not grow by serving their internal economies but by specializing in exports. Thus, they are extremely dependent on their trading partners. In times of economic upswing it is a blessing to be one of the leading exporting nations, but during the current unstable economic times, which are characterized by currency and economic crises of their main trading partners - Europe and the US - growth is strongly reduced (In, 2010).

However, although exportations still play a key role for the growth rate of the BRICs, domestic consumption, investment and productivity growth are now the main economic drivers (UNIDO, 2012). By now, all the BRIC members have understood the necessity of an economical change towards a strong domestic market to ensure a stabilized economic growth.

Domestic small and medium-sized enterprises (SMEs) are according to literature considered to be responsible for a major contribution to economic growth. Especially in unstable economic times when multinational companies destroy jobs, entrepreneurs recognize the huge opportunities and work up the courage to found their own business in their emerging home market. Whereas in industrialized countries the share of SMEs as well as the percentage of people employed in these enterprises is much higher, the promising markets struggle to implement laws and create conditions in order to improve the incentive structure for inhabitants to open their own business. However, all of the BRICs distinctly deal with this challenge and their success is as different as the methods they use.

One of the Big Four, which is definitely lagging far behind in terms of bringing about a promising economical change is Russia (UNIDO, 2012; O'Neill & Stupnytska, 2009). As reported by Schwab et al. (2009) Russia mainly achieved its relative macroeconomic stability due to its oil business revenues. As stated in the Annual Global Competitiveness Research (Schwab et al., 2009), Russia was outperformed by all the other BRIC economies. According to Michailova et al. (2012) some observers have suggested cutting the “R” (Russia) and redefining the acronym BRICs to BICs alleging that Russia cannot be part of this rapid-growing group of huge emerging markets. Kaartemo (2010) assesses the situation as follows: “In Russia [ ] decision-makers are aiming at innovations instead of providing good soil for innovations ” ( p. 261). However, as there are various inhibiting factors such as bureaucracy, corruption and general distrust and de facto no incentives for private business the well-educated people hesitate to become entrepreneurs (Kaartemo, 2010).

As a matter of fact, Russia lags far behind concerning the total number of SMEs to the country’s growth, number of persons employed by SMEs, and the contribution of SMEs compared to the other BRIC states. This thesis will show the vital necessity for pushing SMEs as an economic driving force for Russia to make up ground.

Literature Review

The literature review of this thesis consists of an introduction into BRIC countries in general, their origin and how they differ from emerging markets. Furthermore, the macroeconomic environment of the four member countries will be discussed. Moreover, the importance of SMEs in general will be particularized and thereafter the situation of SMEs in the BRICs will be analyzed. The contingency theory as well as the PESTLE analysis will also be an essential part of this thesis, as they in further consequence will help to analyze and interpret the results from the interviews in the empirical part.

1. BRIC Countries

Especially since the article “Dreaming with BRICs - the path to 2050“ of the investment bank Goldman Sachs (Wilson & Purushothaman, 2003) in which it is predicted that by 2050 the BRICs will have already passed the G-6 nations (France, Germany, Italy, Japan, United Kingdom and the United States of America) as they are supposed to account for 40 per cent of the shares of the global gross domestic product (GDP) - the gross world product (GWP) - at that moment. As reported by Foroohar (2009), eight years later Jim O’Neill, the former head of global economics research at Goldman Sachs, even goes the extra mile and predicts that the BRIC economies will already outperform the combined GDP of the G-6 economies by 2027.

1.1 Definition BRIC

The acronym BRIC was coined by Jim O’Neill (2001) and refers to the emerging market countries Brazil, Russia, India and China. According to Goldman Sachs Global Economic Group (2007), the BRIC countries are “not regarded as typical emerging markets in the truest sense of the phrase ( ), but ( ) a rising and integral part of the modern globalized economy ” (p. 157). O’Neill, the coiner of this economic vogue expression only invented this acronym to describe a shift in the world market and never expected them to really form a political association of emerging national economies (Conway-Smith, 2011).

1.2 Emerging Markets

In order to cover the issue of the relatively modern acronym BRIC, it is essential to first of all describe its generic name - emerging markets. In 1981, two decades before the BRIC nations originated, economists at the International Finance Corporation (IFC) coined the term emerging markets (Khanna & Palepu, 2010) in the course of promoting the first fund investments in developing countries. Emerging economies play a tremendously important role in the world economy since they provide the world’s fastest growing markets for products and services (Verbeke, 2009).

According to Paludkiewicz, Paula and Wohlrabe (2010), the classification of different countries based on their economical development, status or political affiliation has traditionally always been important in the media as there is a great number of common terms, e.g. Third World countries, industrialized nations, emerging economies, G-7, G-20, EU country, Tiger countries, the Next Eleven or OECD and so on.

There is no consistent definition for the frequently used term emerging market in literature (Arnold and Quelch, 1998). A reason for this might be that a couple of different terminologies characterize this concept synonymously, e.g. new industrializing countries, developing countries or developing world. Thus, some authors tried to compile a proper structure in order to define emerging economies on the basis of several criteria. In the majority of cases these include an above-average increasing GDP or per capita income, an accretion of the degree of industrialization as measured by the proportion the manufacturing industry contributes to the GDP or a specific governmental industrialization policy (Strietzel, 2005).

Kvint (2009) tries to define emerging markets as “a society transitioning from a dictatorship to a free-market-oriented economy, with increasing economic freedom, gradual integration within the GMP (Global Market Place) and with other members of the global emerging market, an expanding middle class, improving standards of living, social stability and tolerance, as well as an increase in cooperation with multilateral institutions” (p. 75).

Cavusgil et al. (2002) claim that not every developing country can necessarily be equated with an emerging market. In the beginning of the 1990s several perceptional changes took place within the field of international business. As the following chart shows, emerging markets have a huge growth potential compared to developing nations. This fact can be attributed to the criteria used in this spreadsheet, such as a higher earnings growth or purchasing power.

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Table 1: The Paradigm Shift of International Business (Source: adapted from Cavusgil et al., 2002, p. 3)

Blinder (2006) describes emerging economies as being large, low-cost with an increasingly educated labor pool. Khanna and Palepu (2010) composed a spreadsheet with the most frequently used criteria for defining emerging markets as listed below.

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Table 2: Frequently used criteria for defining Emerging Markets 5

(Source: adapted from Khanna and Palepu, 2010, p. 4)

However, in literature the group of emerging economies is further subdivided into “Big Emerging Markets” (BEMs) as well as “Starting Emerging Markets” (SEMs). Table 3 compares the criteria for both of them.

Big Emerging Markets (BEMs)

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Table 3: Classification of the Emerging Markets (Source: adapted from Bilgin et al., 2004, p. 30)

According to Garten (1997) those BEMs are Argentina, Brazil, China, India, Indonesia, Mexico, Philippines, Poland, South Africa, South Korea, and Turkey.

Due to the fast changing world economy new acronyms for promising emerging markets have sprung up. It all started with the term BRIC in the early 2000s, and was continued by the Next Eleven (N-11), which were also introduced by O’Neill et al. (2005) and consist of Bangladesh, Egypt, Indonesia, Iran, Mexico, Nigeria, Pakistan, the Philippines, South Korea, Turkey and Vietnam. They are considered to be high potential countries with a promising outlook for future growth. According to HSBC CEO Michael Geoghegan (Reuters, 2010) the CIVETS, which include Colombia, Indonesia, Vietnam, Egypt, Turkey and South Africa, will take over in the next ten years.

Furthermore, relatively new acronyms for nations which are assumed to have a brilliant and fast-growing economic future are the MIST countries (Martin, 2012), among them Mexico, Indonesia, South Korea and Turkey as well as the CAPPT nations, namely Chile, Argentina, Peru, the Philippines and Thailand. Another example is the E7 nations, which stand for the BRICs supplemented by Indonesia, Mexico and Turkey as these countries are expected to record an immense consumer boom (Bilgin et al. 2004).

Nevertheless, O’Neill (Project Syndicate, 2011) reserved the term emerging markets for the E7 economies (China, India, Brazil, Russia, Indonesia, Mexico and Turkey) plus South Korea. For all the other most dynamic global markets they use the simple term growth economies. A growth economy is defined as an “economy that is likely to experience rising productivity, which, together with favorable demographics, points to economic growth that outpaces the global average ” (Project Syndicate, 2011).

1.3 Method of Selecting BRIC Countries

However, why exactly have these countries been chosen to be part of the famous acronym BRIC, while there is a range of other fast-developing emerging markets from all over the globe that have been mentioned above?

Besides a huge territory, a large population, and a relatively high share of the GWP, the requirements for the BRIC nations were to fulfill the conditions for growth. These four pillars are first of all macroeconomic stability, which basically includes price stability, a tight monetary policy as well as exchange-rate realignment. Secondly, efficient institutions in terms of legal system, well-functioning markets, health system, financial institutions and the government bureaucracy are presupposed. As a third criterion, the openness to trade and foreign direct investment (FDI) plays an important role. Last but not least, as there are strong correlations between schooling and growth rates of per capita GDP, a proper education system is also essential (Wilson & Purushothaman, 2003).

According to Heese (2009), the Big Four have a key advantage. They are very large in terms of territory, which has allowed them - other than e.g. the Tiger nations (Hong Kong, South Korea, Singapore and Taiwan) - to grow by simply developing the domestic market. Moreover, he claimed that in addition they successfully managed to forward the exportability of their economy. Furthermore, he mentioned their high amount of foreign exchange reserves, their strong positioning as strategic raw material suppliers and potential exporters in global sales markets.

1.4 BRICs or BRICS?

This questionably ongoing trend to analyze macroeconomic key figures of certain countries which hold a lot of promise, take their initial letters and try to coin a good- sounding new acronym does not seem to get out of style. In the recent past, many of them have been created as previously stated. Especially the term BRIC has been altered several times, e.g. BRICET (BRIC + Eastern Europe and Turkey), BRICM (BRICs + Mexico), or BRICK (BRIC + South Korea). Without a doubt, the most frequently used modified version of BRIC is BRICS (BRIC + South Africa) especially because of China’s “proforma invitation” to South Africa to join the political club (Conway-Smith, 2011).

Although their inventor, O’Neill (2001) had his reasons to only select these four countries, after almost a decade the Big Four have admitted a new member in South Africa in 2010 and call themselves BRICS since that date. Back then Wilson and Purushothaman (2003) claimed, that despite South Africa being the currently wealthiest nation in Africa, this country is simply too small, not only compared with the four BRIC countries, but also with other emerging markets whose economic analysis, e.g. concerning their GDP would have been much better. They are talking about the above-mentioned “real” emerging countries, which are besides the BRICs Mexico, South Korea, Indonesia and Turkey. However, China, which obviously had shown great interest in further developing political relations with the African continent and definitely sees South Africa, which is by now China’s most valuable trading partner in the Dark Continent, as an ideal springboard to do so (Conway-Smith, 2011).

For South Africa indeed, it has been a great opportunity to formally become a member of the BRIC nations (Laverty, 2011). Laverty claims that South Africa fondly hopes to improve its global trade connections and receive FDI from the BRICs. He furthermore reported that South Africa expects a lot from the defined goal to increase the inter-group trade between the member countries that provides direct access to a huge class of consumers.

1.5 Macroeconomic Environment

In order to recognize and better understand possible links between the Big Four it is important to get a little overview of the most important country facts and macroeconomic indicators. Table 4 provides an overview of these data from 2012 or the latest possible year available.

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Table 4: Factsheet BRICs

(Source: adapted from the database of the World Bank, 2012b)

For this thesis, especially the last three categories of this factsheet are especially interesting. Due to the different classification principles the number of SMEs registered in the BRICs cannot be seen as statistically significant. However, the SME’s contributions to GDP as well as the workforce employed by SMEs definitely have considerable informational value. Whereas the SME’s contribution of all BRIC countries with the exception of China is on a low level, the small number of labor force employed in the Russian’ SME sector is a clear indication of underdevelopment in this field.

2. Small- and Medium-sized Enterprises (SMEs)

As small and medium-sized enterprises make up to 90 percent of all businesses worldwide and employ between 50 and 60 percent of all workforce (Australian Center of Corporate Social Responsibility, 2007; IFC, 2012a), it is an incredibly important assignment to keep improving the structure of these companies. An economy, which shows substantial, diversified, long-term growth is in most of the cases characterized by a strong and growing SME sector (Beck et al., 2005a). The benefits of SMEs for a country are much higher relatively seen than those of MNCs. As reported by the European Commission (2009) between 2002 and 2008, the average annual rate for newly generated jobs accounted for 1.9 percent in SMEs and only 0.8 percent in MNCs.

Aside from that, MNCs are more likely to exploit the environment they act in. Environment in this context means resources, e.g. workforce (United Nations Committee on Trade and Development, 2002), incurred taxes (Diaz-Berrio, 2011), natural resources (Lucas et al., 1992), and the government. Furthermore, the ongoing trend of MNCs moving from one low-wage country to another in order to minimize their production costs (UN Committee on Trade and Development, 2002) may destroy at a stroke thousands of workplaces. Without a doubt, emerging markets profited from MNCs as there are plenty of advantages and benefits of MNCs, such as knowledge transfer, increasing productivity, FDI and higher wage level for skilled labor (Hijzen & Swaim, 2008).

Nevertheless, emerging markets, especially those at an advanced stage such as in the BRICs should minimize the heavy impact and huge power of these MNCs as they “challenge the sovereignty of a host country, [ ] create political and social division and prevent the development of domestic industries in host countries [ ] and may manipulate prices of imports and exports in host countries ” (Ataman, 2003, p. 50). On these grounds they should aim at a proper economic balance between MNCs and SMEs.

Furthermore, the different reasons for motivation play an important role when it comes to profit reducing complexity as “smaller firms are owner managed firms, aiming at profit maximization, larger firms are manager controlled, aiming at maximizing the managers ’ utility function, including other elements as well” (Aiginger & Tichy, 1989, p. 15).

2.1 Definition and Classification of SMEs

There are several challenges that have to be met when analyzing data about the size of the SME sector across countries regarding comparability and consistency, as different nations adopt different criteria (Ayyagari et al., 2003), BRICs being no exception. In fact, there is no consistent definition of small and medium-sized enterprises. In most of the cases, these criteria to define small and medium enterprises include employment, total net asset, sales, and investment level. It is quite difficult to analyze and compare the landscape of small and medium-sized firms, as there is often a lack of existing data on SMEs and widely diverging definitions used for SME categorization. Nevertheless, especially employment is the basis for definition. The majority of sources defines an SME to have a total of 250 employees. Basically, there are two different accrual methods, namely the qualitative and the quantitative method in order to categorize SMEs (Kayser, 2006).

The qualitative (ordinal) differentiation uses a catalogue of variables full of descriptive criteria that might be applicable to SMEs. The more specific criteria are fulfilled, the more obvious is the differentiation between SMEs and large concerns. According to Glancey (1998) one of those criteria is the nature of the decision-making process of a company. He argues against quantitative differentiations stressing that a firm’s key factors can diverge widely between the individual industries and regions. In SMEs, control and ownership are in most of the cases in the hands of one person. In contrast, in large firms there are on the one hand usually more decision makers and on the other hand they are more likely to act in favor of the company’s shareholders than for the benefit of the firm (Glancey, 1998). However, this method is completely subjective and therefore does not facilitate comparison.

The quantitative (cardinal) differentiation, on the other hand, is based on business key figures that usually may be taken out of the annual reports of the companies. As economic theory almost entirely tends to use quantitative differentiation (Glancey, 1998) this thesis is also based on this type of differentiation for reason of comparability. The European Commission has introduced a definition for SMEs in 2005, which includes staff headcount, annual turnover and balance sheet. Those criteria are not uncommonly used internationally, but with varying thresholds.

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Table 6: Definition of SME in Russia

(Source: adapted from the No. 209-FZ on developing small and medium scale entrepreneurship in the Russian Federation, 2007; exchange rate on 12/03/2014: 1 EUR = 50.748 RUB)

Besides, another way to categorize SMEs is to have a closer look at their level of development of technological capabilities. Arnold and Thuriaux (1997) segmented SMEs into the following four different categories according to their engineering and research abilities.

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Figure 1: Company types according to their level of research and engineering capabilities (Source: Arnold and Thuriaux, 1997, p. 21)

2.2 Importance of SMEs

According to Acs and Audretsch (1993) there are four main contributions to industrial markets made by small firms. Firstly, they play a central role in the process of technological change as they lead to economical success being a source of significant innovation activity. Secondly, small companies stimulate the economy as they on the one hand ensure dynamic competition through preventing corporate concentration and on the other hand provide a mechanism for market regeneration. Thirdly, they create new niche markets especially in developed countries, using their main advantages, such as providing high product quality, flexibility and responsiveness to customers’ requirements (Hallberg, 2000) and thereby support the promotion of international competitive capacity. Finally, small entrepreneurial firms act as an indispensable job generator.

Virenda Gupta, High Commissioner of India in South Africa, (“BRICS should focus”, 2012) stated that “there is nothing more effective than the smaller and medium enterprises when it comes to job creation. Small businesses generate effective and real economic empowerment.“ He further claimed that “ at one time, particular items could only be made by medium and smaller enterprises with large industries prohibited from entering certain sectors.

Small and medium-sized enterprises can play a key role in the growth and development of countries or in other words “entrepreneurship is the main vehicle of economic development” (Anokhin et al. 2008, p. 117). Dejardin (2000) points out that the more entrepreneurs there are in an economy, the faster it will grow. They have the potential to become significant exporters, to promote economic growth, and to alleviate poverty among various groups in a society (Badrinath, 1997). Naudé (2010) mentioned that entrepreneurship considerably contributes to development while boosting structural change and growth, and being an opportunity for people to escape from poverty and inequality. Acs (1999, p. 17) characterizes the importance of SMEs in the following terms:

The crucial barometer for economic and social well-being is the continued high level of creation of new and small firms in all sectors of the economy by all segments of society. It should be the role of government policy to facilitate that process by eliminating barriers to entry and exit, lowering transaction costs, and minimizing anticompetitive behavior by large firms.”

As already mentioned above, SMEs have four main advantages, which is why they are essential for every efficient economy. They function as technology changers, economy stimulators, as well as niche marketer and job generators. In this section, those benefits will be explained in more detail.

2.2.1 Technology Changer

Although SMEs account for a small fractional part of total business R&D in the OECD, the contribution of SMEs to the innovation system is immense. SMEs introduce new products and adapt existing products to the needs of customers. For reasons of low R&D expenditures, SMEs have a competitive advantage (Acs & Audretsch, 1990).

Schumpeter (1934) argued that innovations give companies temporary monopolies. These monopolies last as long as competitors do not copy or improve their innovations. Schumpeter (1942) assumed that large-scale enterprises are more successful innovators than their smaller counterparts. However, he further pointed out that the higher the degree of bureaucracy within a company is, the less innovative ideas will emerge. He started from the assumption that the larger a company is, the more likely it is to increase bureaucracy and as a result, it may lose its innovative strength. Thus, leading to macroeconomic stagnation.

As a matter of fact, nowadays, smaller firms are the driver for innovation. Although large firms tend to be ahead of SMEs when it comes to design-driven innovation, e.g. in factory automation, small firms often have the upper hand concerning discoverydriven, or in other words experimental innovation (Carlsson, 1999). Acs and Audretsch (1988) found the correlation between patents and the rate of product innovation and production innovation to be rather low among larger companies and, on the other side to be much higher among smaller firms.

Zimmermann and Schwalbach (1991) examined German SMEs and found out that they are much more likely to patent than larger firms. Bound et al. (1984) examined U.S. companies and also found an above-average number of patent applications by small companies. It is also confirmed by literature (e.g. Gellman Research Associates, 1976, 1982; Audretsch, 1995) that innovation activities carried out by SMEs are much more successful than the ones of larger companies.

Gellman Research Associates (1976, 1982) were pioneers in terms of identifying, counting and ranking innovations. They found that small firms are contributing 2.45 times more innovations per employee than large-scale companies. Moreover, SMEs are found to be more considerable, giving new technological directions (Gellman Research Associates 1976, 1982; Edwards & Gordon, 1984). Almost twenty years later, Audretsch (1995) confirms this fact finding that SMEs contribute 2.38 times more innovations per employee than do big companies. Thus, Schumpeter’s (1942) above-mentioned basic premise that large firms are the drivers of innovation can definitely be refuted. Furthermore, Chakrabarti (1991) used data for U.S. SMEs and detected that small companies contribute much more to innovations per dollar of research and development expenditure than do their larger counterparts. Besides, the number of innovations per employee is usually higher in small high-tech companies than in larger ones.

Scherer (1988) suggests three main reasons why SMEs are obviously engines of technological change and innovative activity, mainly because large firms and SMEs usually use totally different types of management structures (Scherer, 1991). Larger concerns are in most of the cases characterized by strict hierarchic structures. Consequently, decisions whether to undertake new cost-intensive and risky R&D programs or not, have to pass through long-winded and complex processes on different administrative levels. Large companies on average tend to be more risk averse than SMEs are. Thus, lots of new ideas are not going to be turned into action.

On the other side, decision-making processes within smaller firms are usually implemented by only a few decision makers which extremely eases the internal vote on a new project. As already mentioned above, huge companies are bogged down by bureaucratic inertia. Moreover, larger firms tend to generously reward employees for successful research and often promote them to higher positions which costs the company twice the amount of money. Hence, SMEs have a couple of competitive advantages being faster and acting more cost-effective when it comes to R&D investments. Second, many advances in technology accumulate on a great number of detailed inventions involving individual components, materials and fabrications techniques. The possible sales for creating such detailed advances are in most of the cases too small and therefore not a lucrative business for large companies. Third, it is easier for SMEs to keep their researchers motivated, as in small organizations links between challenges, staff, and potential rewards are tight (Scherer, 1988).

Furthermore, according to Audretsch and Vivarelli (1994) SMEs boost their innovative strength by exploiting knowledge that is created outside the firm, mostly often in research associations with universities. Audretsch and Vivarelli (1994) moreover not only found that there are R&D spillover effects from universities to small companies but that they are much more significant for small firms than for large ones.

2.2.2 Economy Stimulator

Entrepreneurship and small companies are important determinants of economic growth (Audretsch & Keilbach, 2004; Audretsch, 2007). Furthermore, entrepreneurship is seen as a crucial activity driving a wedge between knowledge and the total factor productivity by overcoming the gap between innovations and specific parts of technological knowledge by creating new firms (Solow, 2007). However, Acs and Audretsch (1993) pointed out that there are two characteristics of SMEs explaining why they are an economy stimulator, namely competition creating and providing a mechanism for market regeneration. Acs et al. (2008, p. 219) stated that “entrepreneurship is considered to be an important mechanism for economic development through employment, innovation and welfare effects”.

Furthermore, according to Naudé (2010) entrepreneurship is crucial for economic development as many of the most binding restrictions are channeled through entrepreneurship. Naudé moreover claims that the essence of what drives economic development is a good match of entrepreneurial talent, productive technologies and possibilities for growth. Carlsson (1999) supports this statement claiming that not only small companies themselves but the connection between them and entrepreneurship makes small business essential for long-term economic growth.

Dynamic Competition

Kitson and Michie (1998) state that firms operate within a vast number of competitive environments. According to them there are on the one hand companies that compete in atomistic markets, which are characterized by a lot of customers and competitors, and where the drivers of competition are price and cost factors. On the other extreme they see firms, which may operate in monopsonistic or monopolistic markets and do not have effective competitors or only one customer. When companies stop facing real challenges they tend to lose their dynamics. Thus, the economy stagnates or in the worst case decreases (Carlsson, 1999).

Successful SMEs however, may enter these monopolistic markets and provide competition. Beck (2005) summarizes the ideas stated by The World Bank claiming that the SME sector positively contributes to social benefits as SMEs create greater competition and therefore are often more productive than their larger counterparts. Not uncommonly small firms serve as catalysts for economic growth as the already mentioned innovation power creates a competitive advantage (Acs & Audretsch, 1993). Hence, small firms bring change as well as competition as they shift the market structure (Acs, 1999). Although the degree of business volatility in an economy strongly positively correlates with its growth rate economical turmoil it is more a side effect than the reason for economic growth (Carlsson, 1999). Real growth can only be established if the newly generated jobs and founded companies manage to expand their innovations in the economy.

Mechanism for Market Regeneration

Acs and Audretsch (1993) state that the market turbulence small firms create does not only enhance competition that is likely to result in less static measures of market structure, such as concentration, but also provides mechanism for regeneration. Hence, according to Acs and Audretsch (1993) SMEs serve as drivers of change in a market. They moreover claim that although there is no systematic evidence that allows identifying whether small firms are more productive than larger firms, it was found that small firms still positively contributed to net employment rate especially in turbulent economic times, while their larger counterparts reduced employment. While Acs and Audretsch (1993) picked the instance of the steel industry in most developed countries, Ayyagari et al. (2011) who focused on developing countries also found that even in years when a country faced an aggregate net job loss, only small firms created jobs. Hence, one may deduce a market stimulation in difficult economic situations.

2.2.3 Niche Marketer

Another advantage of SMEs that is strongly related to the first two sub-points is creating new niche markets, which are promoting international competitiveness (Acs & Audretsch, 1993). As reported by the OECD (2000), specializing in a market niche compensates for some of the drawbacks small firms face due to their small-scale production. The OECD further states that especially small firms are likely to choose extremely specialized markets or innovative niches that in most of the cases exist in the home country as well as in foreign markets. These usually high-tech companies not uncommonly have between 70 and 90% market shares and due to their high export orientation support the international trade surplus. However, their strong specialization results in a disadvantage in terms of economies of scale. The OECD cited an executive of such a successful niche marketer company that makes laboratory equipment who explained that the typical Mittelstand strategy as follows: "If you are small, your front of attack has to be narrow. You'd better focus your business. And if you are focused, you have to find customers for your specialty all over the world in order to recoup your R&D investment." (OECD, 2000, p. 13).

Those looked-for customers are in many cases larger companies that outsource certain activities to more specialized smaller firms. The fast changing technology in many industries requires a higher degree of specialization in certain activities. As large firms are usually much more bureaucratic than their smaller counterparts and often provide less direct personal incentives they tend to have certain services carried out by SMEs. These services are basically not only highly knowledge-based but also are too cost intensive to realize in large organizations that are very hierarchically structured (Carlsson, 1999).

On the other hand a huge advantage arises from being a specialist in a narrow market - flexibility and the benefits of a flexible specialization (OECD, 2000). This flexible production is characterized by five important factors. First, due to their multi- purpose equipment and their highly qualified employees that are able to appropriately use it, the small niche players may at any time flexibly react to customers’ (changed) demands. Second, the continual innovation entails constantly improving products, production and organization methods. Third, working on the same product, a group of enterprises that is not considerably spatially dispersed may exchange new ideas, transmit knowledge and manage to develop institutions that in further consequence enhance effectiveness (clustering). Furthermore, networking between enterprises, enables them to facilitate economic specialization, build subcontracting relationships and get superior access to information. Last but not least the resulting spillover effects have to positively be mentioned. This flexible production system usually outperforms those based on mass production (OECD, 2000).

Nevertheless, so far these highly specialized SMEs are as a matter of course the exception rather than the rule and in most of the cases their countries of origin are developed ones. Less than five percent of all SMEs are technology developers. Hence, according to the OECD (2000) there is a need to push the support of SMEs in developing countries to catch up since only about five percent of the national research budgets are invested in SME-related programs. The OECD (2000) therefore recommends governments to amend their research and development and SME policies in order to increase the number of small and medium sized companies that may benefit from innovation programs as shown in Figure 2.

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Figure 2: Two-dimensional plot of SMEs according to their innovative capacity (Source: OECD, 2000, p. 20)

According to Dodgson (1990) prime examples of such high-technology SMEs operate in (international) niche markets and their competitive position is not based on price but on e.g. technological leadership. Moreover, the selection of the niches has to fulfill several criteria. Firstly, the size of the potential market has to be a promising one. Secondly, tough, direct competition from large, financially often superior, firms should be avoided. Thirdly, another crucial factor is that it has to be possible to maintain the technological leadership this particular niche over competitors over a certain period of time in order to make sure to recoup the high expenditure on research and development and marketing (Dodgson, 1990).

2.2.4 Job Generator

Small firms are said to be a job generator. Birch (1979), who examined the labor market in the US, reports that in the 1970s eight out of ten new jobs had been contributed to by SMEs. Hence, he argued that small companies are especially important in job creation. Haltiwanger et al. (2010), who analyzed companies in the United States over the period 1992-2005, underline this statement claiming that net job growth rates tend to be higher for smaller than for larger businesses. They further found that the smaller the size class of a company is, the higher is the average annual rate of net employment growth. In contrast, a probably more expressive research on this topic was done by Ayyagari et al. (2011) who surveyed almost 50.000 companies in 104 developing countries over the period 2006-2010. They found that small firms tend to create more jobs in low-income countries than highincome countries. Furthermore, they detected that although in a lot of countries small companies do not employ the majority of people, they nevertheless contribute most to employment, across country income groups.

Moreover, Ayyagari et al. (2011) also found that the smallest firms with less than 20 employees generate more than 45% of the jobs and tend to be even more dynamic if they are young businesses. Even in those countries that had an aggregate net job loss, only the small firms still generate jobs. They further claim that large firms have the largest share of job losses. Beck et al. (2005) also found that SMEs are a real job generator surveying 54 countries (mostly developed) and found a strong correlation between the small firm sector and GDP/capita growth. However, Beck et. al. (2005) did not find an evidence of causality.

Davidsson et al. (1999) argue that during times of economic recession and recovery SME seem to lag in the downturn, meaning that while job losses of small firms still do not outweigh their job creation their large counterparts already reported a negative net job generation. However, SMEs on the one hand do not only delay this negative effect of a rise in unemployment in turbulent economic situations but on the other hand they are also the driving force for recovery. Their employment-wise upswing results in earlier and more rapidly rising growth in gross job creation. Hence, SMEs are essential for job creation. Furthermore, positive or, at the worst, neutral effects could be found analyzing the relationship between small firm dynamics and local economic prosperity (Davidsson et al., 1999).

For a long time in many economies SMEs had been constrained by governments as they were seen as not to be as efficient as larger companies. However, although small firms can, from a very static point of view, be seen as less efficient in terms of production as they logically cannot reach such a high level of economies of scale and scope compared to their larger counterparts, SMEs create another type of efficiency. They contribute to economic efficiency by providing dynamics and evolution. Thus, since the 1990s many government policies have shifted away from restraining to supporting small firms as they saw a need to accelerate the substantial contribution of small firms and to constrain, mostly large, companies from misusing their market power. Moreover, the intended positive side effects of this pro-SME shift are job generation, economic growth, and improved international competitiveness (Audretsch, 1999).

2.3 Entrepreneurial Motivations

In order to better understand some links between the four main contributions to industrial markets made by small firms, as described above, it is essential to know that many of those competitive advantages of SMEs often stem from the dynamism of the entrepreneurs. Furthermore, a main reason why less developed countries tend to have a weaker SME sector will be disclosed.

Reynolds et al. (2001) sort the motivators, i.e. reasons for starting a business into two groups: opportunity or necessity. In literature they are also called “pull” and “push” motives. Pull motives are autonomy including freedom and independence, challenge, income and wealth, appreciation and status, whereas founders with push motives act under a certain constraint, e.g. when people are (afraid of becoming) workless (Hessels et al., 2008), struggle finding employment, do not draw enough salary, job dissatisfaction, or simply do not like their inflexible work schedule (Segal et al., 2005). These authors further claim that whereas push reasons play a key role in developing countries, in developed economies, pull motives are predominant.

Hessels et al. (2008) further claim that push motives are an extremely poor starting condition for ambitious founders. However, it also strongly depends on cultural aspects and how firmly the “entrepreneurial spirit” is anchored in a certain culture. In Europe this entrepreneurial drive is proven as not to be as high as in the United States of America. In the following section the three most investigated and probably most significant motivational factors are described in detail.

Although this motivator is not necessarily a driver for the growth of one’s business it serves needs related to freedom. The entrepreneur is able to set one’s goals, explore methods that he or she thinks might work best to reach these goals and remains flexible due to the free time management (Breaugh, 1999).

However, entrepreneurs, who are mainly driven by this desire for independence, in any case may contribute to the diversity of an economy only because of the fact that the way they do things is unique (Hessels et al. 2008). Moreover, as one of the key entrepreneurial motivators, autonomy is an intrinsic motive (van Gelderen & Jansen, 2006) and therefore has a positive impact on creativity (Amabile 1996). Hessels et al. (2008) claim that founders who are primarily motivated by freedom and autonomy positively relate to an innovation-oriented entrepreneurship.

Income and wealth

In contrast to the previous motivator, according to Hessels et al. (2008) income- motivated entrepreneurs tend to increase both growth and innovation, as those variables are adjuvant to reach a higher level of financial wealth. These authors further found that the higher the income level of a certain country, the lower the number of income-motivated entrepreneurs. Moreover, they found that economies with high growth rates are more likely to have a higher share of increase-wealth- motivated entrepreneurs who contribute to job creation and export aspirations.

Push motive

Although necessity-motivated entrepreneurs have to face an everyday struggle for survival and thus are more or less forced to be motivated there are several issues causing them to fail. As the likeliness that necessity-driven entrepreneurs are found in financially poorer regions, they tend to be more limited in their access to external finance, human resources, technology and other capabilities and resources. Hence, developing or i.e. less wealthy countries are less likely to push innovations, job growth, or achieve a significant competitive advantage. Therefore, push-driven entrepreneurship does not result in a significant increase in innovation or growth (Hessels et al. 2008).

Segal et al. (2005) claim that people become entrepreneurs principally because of pull motives, rather than they are pushed to their profession by negative external forces. Although the majority of entrepreneurs in Russia do start their business voluntarily still many Russians are necessity-driven entrepreneurs as the following graph shows.

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Figure 3: Motivators for Russian entrepreneurs to start a business

(Source: adapted from the Global Entrepreneurship Monitor, 2011, p. 27)

Entrepreneurial motivators, however, may change in the course of time. For instance, if people in the very beginning were autonomy-motivated, with the passage of time, they may be driven by income and wealth motives (Hessels et al. 2008).

2.4 Barriers in SME Development

According to Ayyagari et al. (2011) especially in developing countries, SMEs face numerous of institutional barriers to a limited access to finance, an insufficient juridical system and legal enforcement as well as weak property rights protection. The World Bank (2013) in cooperation with the International Finance Corporation annually compares business regulations for domestic companies and ranks the majority of countries (189 in 2013) in the world according to their ease of doing business for small firms and how their regulations developed over the last years. The World Bank (2013) therefore uses ten general areas of interest for businesses: set up a business, handling of construction permits, receiving electricity, registering property, obtaining access to credit, protecting investors’ rights, paying taxes, trading internationally, enforcing contracts, winding up insolvency proceedings and employing staff. Table 7 shows in detail the sub-points for those crucial factors.

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Table 7: Crucial practices to ease doing business for SMEs (Source: adapted from the World Bank, 2013, p. 17)

The World Bank (2013) ranks each of those categories separately compared to the other countries surveyed. The average of all those ranks gives the final placement. This study will be especially important when comparing SMEs in Russia with those in the other BRIC member states.

According to Klapper et al. (2004) entry regulations definitely impede starting a business. They found that in countries with high entry barriers the value added by the industries increases slower than in countries with low entry barriers. Entry barriers in general tend to occur especially in developed economies that are less corrupt. Furthermore, these authors claim that access to finance and regulations, which protect intellectual property facilitate entry while regulations interfering labor flexibility make it particularly harder for small firms harder to enter the market than for their larger counterparts.

Managers of small firms not uncommonly mention that it is quite tough to compete with larger companies as they have huge advantages in selling and marketing as well as their higher budget for research and development (Pratten, 1991). Moreover, small firms in many cases lack basic management skills (Baldwin & Johnson, 1999; Dunkelberg & Cooper, 1990) when they enter the market and need to obtain professional knowledge in order to survive (Baldwin & Johnson, 1999). In general those SMEs begin smaller, pay low wages (Agell, 2004), and tend to have lower labor productivity (Baldwin & Johnson, 1999). According to Acs et al. (1999) one of the main reasons for the limited access to finance can be explained by the inadequate management competence. These authors further claim that this lack of appropriate human capital explains why SMEs do not even account for ten percent of all business finance activities. Hence, with specific training courses, small firms increase their chances to ease the access to external finance, as it is important to have various sources of finance optimally adapted to a certain company.

However, not only the limited financial access is a huge drawback for SMEs but also more obvious and already mentioned difficulties of small firms, e.g. the economies of scale and scope, can be solved to some extent. Pratten (1991) examined the importance of four different sets of relationships for SMEs. First of all, he examined the relationship between SMEs and large companies. In this type of relationship small firms usually act as subcontractors for large firms. If SMEs are able to specialize on products, operations or services that large firms need to subcontract because of limited economies of scale and are probably able to find other (large) customers, even small firms may easily increase their economies of scale. Secondly, the relationship to other local firms which are producing similar goods and services and that are not significantly spatially dispersed may have positive impacts for small firms. They may be supplied with special components, get advice, or even hire high- qualified staff from other local firms. Furthermore, relationships with universities and polytechnics may be a competitive advantage, especially if a firm needs support with R & D questions, product development and product certification.

Probably the most unimportant relationship of SMEs is the one to government and local authorities. Nevertheless, many small firms receive grants for product development and get advices in areas where SMEs often lack in, such as marketing. Hence, they gain management skills and in further consequence are more likely to improve their chances to access to external finance as noted above. Although all of those relationships could be beneficial, Pratten (1991) further claims that the advantage a small firm may take of these different sets of relationships heavily depends on the branch of the SME.

2.5 SMEs in Brazil, India and China compared to SMEs in Russia

Many governments, also among the BRIC states, are aware of the immense importance of SMEs, as they often rate the development of the SME sector high in their reform agenda. Nevertheless, lots of them struggle to appropriately implement their programs to improve the SME business environment. According to Ayyagari et al. (2003) there are various business environment indicators, which correlate with the size of the SME sector in a certain economy, such as entry costs, exit costs, costs of contract enforcement, property rights registration, the access to finance as well as the rigidity of the labor market.

In order to ensure a consistent data collection, statistics raised either by the Russian Federal State Statistics Service (Rosstat) or OPORA RUSSII, the All- Russian Nongovernmental organization of small and medium business, will be favored over others. Furthermore, for comparability purposes, all currencies have been converted into euros. According to the Doing Business Report 2014 (World Bank, 2013) Russia in some aspects can definitely be compared to any SME-friendly developed country, e.g. the ease of enforcing contracts or registering property. Nevertheless, in some points, e.g. the ease of protecting investors, getting credit, trading across borders, or dealing with construction permits, Russia competes with developing countries and is on the bottom of the ranking as Figure 4 shows.

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Figure 4: Results for the Russian Federation on Doing Business Report 2014 (Source: World Bank, 2013, p. 8)

2.5.1 History of Russia’s SME Tradition

Since Russia’s adoption of the market economy in 1991 the number of registered SMEs increased more than six times from 266,700 to 1,668,300 in 2010 as the following graph shows.

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Figure 5: Development of the number of SMEs in Russia (Source: adapted from APEC, 2011, p. 2; Bleck, 2011, p. 7)

According to Kihlgren (2003) due to its former Communist leadership that lasted from 1918 to 1991, Russia in fact does not have an entrepreneurial tradition. This author further states that Russia had heavily been influenced by interest groups during the perestroika which resulted in mainly unproductive entrepreneurial activities. After an encouraging start in 1992, fast privatization in 1994 and 1995, and stabilization actions in 1995, the initially ambitious reform process became sluggish (Fischer & Sahay, 2000). These authors further argue that the second presidential election in the history of Russia in 1996, Yeltsin’s reelection, has turned out to be an obstacle to the development of Russia’s economy by deepening corruption. They moreover argue that under the authority of president Yeltsin, Russia missed the opportunity to invest its easily earned riches from oil sales to push the local economy by fostering entrepreneurship.

Fischer and Sahay (2000) even claim that the Russian financial crisis in 1998 could have been avoided, if the reform plans had been implemented without any compromise. They further claim that the combination of unsolved fiscal problems, almost unlimited access to external capital, and the ongoing capital flight resulted in a huge fiscal deficit and a considerable debt in the short run. The deterioration of external environment, in particular the rapid fall of the oil prices and the increased costs of and reduced access to foreign financing, and an enfeebled banking system causing incredibly inflexible exchange rate, the so-called Ruble crisis could not be prevented.

Kilghren (2003) in contrast, assumes that political actions do not play a significant role in the development of small firms after granting economic freedom. He assumes that individuals try to make use of new opportunities and thus, the importance of small businesses tends to increase steadily. However, he found that in comparison with other transition nations (he examined in detail Poland, Hungary and the Czech Republic), where a continuous improvement process took place, Russia was an exception. A lack of stability in the macroeconomic environment, first and foremost caused by high inflation for a number of years as well as the budget deficits, led to below-average growth of the SME sector. It is well known that stability is a critical factor for firms when planning to invest.

[...]


1 Central Intelligence Agency, 2013

2 Häner, 2011

3 APEC, 2011

4 Goyal, 2013

5 Ministry of Commerce People’s Republic of China, 2012

6 IFC, 2012b

Details

Pages
145
Year
2014
ISBN (eBook)
9783656657606
ISBN (Book)
9783656657590
File size
1.2 MB
Language
English
Catalog Number
v273892
Institution / College
University of Linz – International Management
Grade
1
Tags
Russia SME BRIC BRICS Small- and medium sized enterprises

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Title: The Importance of Small- and Medium-sized Enterprises in Russia in relation to the other BRIC countries