Enabling Growth of Micro Small and Medium Enterprises

As per Government estimates, it employs 25% of the total working population and contributes roughly 30% to the GDP of the Country. Latest Government estimates reveal that MSME is moving on strong foothold to employ around 40% of the country’s working population and is poised to contribute 50% to the GDP in coming 5 years. Yet at the same, there is growing vulnerability of the companies and entrepreneurs’ within the MSME, not primarily because of ongoing COVID-19 crisis, although it appears to be a catalyst, but because of inherent structural challenges that engulf the MSME sector.

Experts and Industry Unions are pushing for a solution from the Government to ease monetary policies and make availability of funds at a cheap rate so that MSMEs can sail through. Would seeking financial relief from Government be good enough? Counting on such measures will not make the sector free from its inherent structural challenges as could be seen in case of some of such high leveraged sectors. Some of the important structural challenges, faced by MSMEs, to be addressed are:

1. Lack of Financial Literacy

Most of MSMEs, if not all, either are individual/proprietor driven or are operated and managed by the promoters who also happen to be directors of the Company(ies). Largely, either first generation or second generation entrepreneur’s sit at the helm of the affairs having little or no knowledge on financial aspects of the business, for them finance – simply put is a peripheral function or merely a cost center and not as important as other business functions. Little do they know that with elongated receivable cycles, low margins, uncontrolled overheads, they often resort to increased borrowing as the only way out; literally unware of the debt trap that they are heading into. When working capital fall short to address the business needs due to ill managed inventory controls and receivable cycles, they often resort to term loans (including LAP) to bridge the gap between the working capital cycle; leading to asset-liability mismatch given the interest rate yields for the longer term borrowings. The result is liquidity crunch that often percolates to solvency issues.

As per RBI publication as on September 2018, Rs. 14.3 lakh crore was credit outstanding to MSME sector, out of the same the NPAs were staggering 38%. On ground, the current situation appears to be grimmer. It is experienced that MSMEs are financially not well equipped to hire experts, and consultants, this is where the banking partners’ should pitch in and regularly hold meetings to understand the financial challenges faced by the businesses and the reasons for increase in borrowings.

2. Low Levels of Capital Invested in Business

A survey done by MSME Ministry in 2017 deciphered the average debt-equity ratio of MSME at 4:1, varying to a great degree within, depending upon the size and stage of an enterprise as well as sector in which it operates. Heavy reliance on debt capital or high leveraging (both formal and informal) makes MSME dependent upon the external finance to survive and operate. With little value addition, low margins, asset-liability mismatch, the MSMEs become the most vulnerable in challenging times. As a result, banks’ are more skeptical to lend fearing deteriorating asset quality.

Therefore, it is of utmost importance that business cycles are regularly monitored and a higher threshold of promoter capital be introduced. Norms acceptable to large enterprises cannot be made applicable to MSMEs, obviously, this step shall not go well in short term but in long run the results will be astounding, to say at least.

3. Diminished Corporate / Professional Structure

It will not be unusual to say that most of MSMEs (prior to change in definition) are nothing more than the glorified proprietorship (95.98% of the MSMEs were proprietary concerns – Annual Report MSME 2018-19), wherein the owner is also the manager or the owner is the one who is at the helm of the affairs i.e. largely one man driven organizations, the other family members are also part of the management with little or no say in business/managerial operations, i.e. namesake managers. In such organizations, the control is often transferred by pedigree and not by the value addition.

View this inherent structural challenge along-with the limited financial resources and crunched bottom line, the result is disastrous in terms of retaining talent. What this invariably promotes, is the “yes” man culture; therefore the professionals are hard to attract and if attracted, hard to retain.

The solution to this challenge lies within, as the owners will have open up in defining the roles and responsibilities in a more coherent manner so as to benefit holistically. They have to understand the hiring and retaining talent is the life blood for business to survive and grow and it is not expenditure rather an investment in business.

4. Low Level of Research and Development

The work flow to MSME is largely governed by the multinational companies, having finance and market dominance at their disposal. Often, these multinationals dominate on the every aspect of business, say design, the production process, work flow, raw material procurement, vendor management and much more; leaving negligible headroom for the MSME owners to put in their brains behind the business thereby killing their entrepreneurial instincts. Well, there’s no dispute that the volumes are high and hence the sector remains occupied and at times pressed for more work. While the occupancy remains high, the margins continue to remain wafer thin as every business aspect is dominated.

The result is cut in research and development expense turning MSMEs primarily into job-workers, thereby jeopardising the future growth prospects. The situation becomes more challenged with crisis like the current, wherein the sector is unable to withstand the pressure owing to low margin and inability to move up the value chain. Inadequate investment in research and development initiatives remains a structural challenge within the sector. The solution lies in adopting disciplined approach towards business and structuring the organisation in such a manner that strict financial and managerial control persist.

Conclusion: A Balanced Structural Roadmap

The challenges are mix bag with some capable of being solved from outside, while others require more balance approach from within. Whereas Government policy and assistance can help MSMEs survive or withstand the turbulence, as the current one. The longer term and more viable solution lie in understanding the inherent and structural challenges and solve them in more creditable ways.

The sector has to come to the terms with the fact, that support from outside shall not be indefinitely and infinitely available and thus value creation or moving up the value chain remains the only available option to steer through unforeseen and uncertain times. In medium term, Government will have to hand hold the sector and organisations within to make them more self-sustainable, they have to arrange for more skill generation programs. To strengthen this sector, Government has to formulate the schemes for the even longer term solutions rather than providing relief as and when the needs arise.