Future of SMEs in India: Opportunities and Challenges

A report submitted to

Prof. Deepak Sinha

as part of academic requirement for Course titled

Corporate Strategy

by Group 1 Aravind V (1011157) Neha Rani (1011186) Chaitanya Kumar P (1011305) Sagarika A (1011348) Sylvia Grace (1011366)

Contents
........................................................................................................................... 1 Future of SMEs in India: Opportunities and Challenges......................................1 Contents................................................................................................................ 2 Introduction........................................................................................................ 4 Advantages of SMEs...........................................................................................4 Challenges faced by SMEs..................................................................................5 Capabilities and resources required to emulate large enterprises:....................7 Role of Government: Existing policy and drawbacks .......................................11 Comparison of SMEs: India vs. Other developed countries ..............................13 The Role of Government in SME Development in Transition Economies David Smallbone............................................................................................................ 14 Do SMEs in India have the potential to become giants in next few years?.......16 Industry-wise analysis......................................................................................18 Conclusion: the future of SMEs in India............................................................21 Exhibits............................................................................................................. 22 Exhibit 1: abbreviations....................................................................................22

Introduction
Small and Medium Enterprises play a vital role in the growth of the Indian economy. India sees a dominant presence of SMEs in both manufacturing and service sectors. According to the ministry of MSME, a small service enterprise is one where the investment in equipment is between ten lakh and two crore rupees and a medium service enterprise is one where the investment in equipment is between two crore and five crore rupees. A small manufacturing enterprise is one where the investment in plant and machinery is between 25 lakh and five crore rupees and a medium manufacturing enterprise in one where investment in plant and machinery is between five crore and ten crore rupees. According to estimates, in terms of value, the sector accounts for about 45 per cent of the manufacturing output and 40 percent of the total exports of India. The SME sector employs about 42 million people in over 13 million units throughout the countryi. There are more than 6000 products, ranging from traditional to high-tech items, which are being manufactured by the Indian SMEs. In India, 95 percent of industrial units are in small-scale sector with a 40 percent value addition in the manufacturing sector. Indian SMEs are important to the Indian economic system as they provide second highest employment levels after agriculture. Their potential to generate employment, bolster exports and bring flexibility into Indias business environment drives the Indian policymakers to concentrate on SMEs.

Advantages of SMEs
Customer service:

SMEs understand end customers needs better given their proximity to them. Thus, they are in a better position to offer personalized services to customers.
Flexibility:

SMEs are very agile because of their lean structure and their inherent ability to sense market changes. This is possible because of small size of their target market and easy access to

market place information. Thus, SMEs have the advantage of faster and better adaptation to new needs, tastes and preferences of consumers.
High labour productivity:

Workers in SMEs are more motivated in than those in large enterprises because of their continuous interaction with employers and very closely knit workforce.

Challenges faced by SMEs

Low access to funds:

The main challenge faced by SMEs is timely and adequate access to funds. This is because banks and other financial institutions have a bias against small loan portfolios. To circumvent this problem, RBI formulated guidelines that banks do not insist upon collateral against a loan to SME. Also banks are sceptical to lend to SMEs mainly because of lack of transparency regarding their financial conditions. Evidence states that a significant proportion of lending to SMEs in transformed into NPAs. This makes banks/other Financial Institutions (FIs) to be risk averse until they get detailed financial information about the concerned small/medium enterprise. For e.g.: Statistics say that around 98% of sick units are from small scale industries. These numbers put the lenders at much higher risk. SMEs tend to receive very little investment, including both foreign direct investment and local private investment. They are often seen as too small by investors or too large to receive support from microfinance institutions and development agencies.
Lack of adequate systems:

SMEs face problems due to lack of standardization and proper planning. Half of these problems might be attributed to lack of proper IT systems in place. Because of lack of proper IT systems, SMEs face the problem of collecting and archiving information for further use.

Lack of skilled workforce:

Though SMEs help the economy by creating employment locally but because of attractive wages offered by large enterprises, it is difficult to retain talent in SMEs. Also, the flat structure of SMEs restricts the prospect of growth for employees and this might hit their career goals, leading to dissatisfaction and attrition.
Lack of proper infrastructure:

Low access to funds is often transformed into poor infrastructure. These infrastructure gaps are different for SMEs in urban and rural areas. Amongst others, the prime infrastructure related problems are irregular supply of electricity, water supply, poor communication facilities etc. Similarly, poor transportation facilities, especially in rural and semi-urban areas have been cited as constraints encountered by small enterprises in gaining rapid access to newer and larger markets.
Narrow focus:

Trade liberalization has increased the capacity of well-established foreign manufacturers and retailers to penetrate both remote and underdeveloped markets. Thus, global competition confronts purely domestic, whose product and sales are extremely localized and/or segmented. Against this development, local SMEs find it increasingly difficult to survive or even maintain their current business position in their respective markets.
High costs in development:

Local SMEs are at a disadvantage with respect to latest technology, machinery etc. Thus, the adopt conventional ways of production, which increases their cost and production time. Major problem with Indian SMEs is that they operate at very low scale of production and this hinders their capacity to reduce the costs of products and engage in technological upgrades. Capturing a certain scale of operations is very critical in SMEs growth path.

Less R&D:

SMEs have rich knowledge of local markets but they do not have the required expertise to innovate rapidly and provide new market offerings.
Inadequate business protection plan/ Inability to withstand downturns or shocks

SMEs dont have an adequate business protection plan to protect them from downturns or business risks. This is important because owing to their small size and limited resource availability, SMEs are more prone to buckle under downturns or misfortunes in business. Therefore, it is very important to identify possible negative shocks or business risks that are most predominant among small firms and take appropriate measures to minimize those risks by suitable business protection plans. The business risks that SMEs are vulnerable to are excessive dependence on single supplier or distributor, late payment disrupting the working capital management, price fluctuations, dependence on single promoter, ignorance of international environmental and IP laws. SMEs in many cases are either unaware about the possible business risks, or wherever they are aware, have limited financial capability to have a hedged exposure to such risks.

Capabilities and resources required to emulate large enterprises:

Building competitiveness in production:

SMEs can be made competitive by reducing the costs in production, strengthening product service/quality. To attain competitive position, SMEs should concentrate on building superior technological expertise, strengthening marketing and sales strategies to cater to larger group of customers. It should also make conscious efforts to recruit and retain talented pool of workers.

Cluster formation can enhance the competitiveness and sustainability of the SMEs. For example, the auto components sector in India is dominated by SMEs. The SMEs in the auto component sector had formed clusters in 3 regions: Gurgaon, Chennai and Pune. These clusters provide ideal setting for SMEs to access support systems, increase participation in international markets, disseminate best practices, infrastructure amongst themselves. enhance cluster competitiveness. and distribute the fixed costs of

Creation of export consortia can also be applied to

Catering to international (large) markets:

SMEs have poor access to international markets. This is not just due to the shortage of funds and investment, but also due to difficulties confronting SMEs in identifying foreign business opportunities, contacting potential overseas customers, and accessing export distribution channels. As a result, SMEs are less likely to be able to export directly and often end up being sub-contractors for recognised companies. To circumvent this, SMEs should understand government policies clearly and try to work in close collaboration with various government agencies. After export duties are cut down drastically, with the introduction of STPIs and SEZs, these small and medium enterprises should look at targeting international markets.

Innovation in product offering and quality:

SMEs should formalize the information they get from the marketplace in systems. This information should be used to understand consumer preferences and innovate accordingly.

To build this capability, they need to work with large enterprises to use physical resources on a shared basis. Also, SMEs need skilled human resources to improve their R&D capabilities. This capability can be built by tying up with education institutions and other service agencies and impart superior training to their employees on best business practices in the sector of their operation.

Difficulty in scaling up due to informal operation systems

SMEs that are successful as small ventures may face strategic, operational and organizational challenges in managing their growth to the next level. Most of the SMEs have an informal operation systems in place that may be sufficient to cater to low-volume needs. However, as an enterprise grows larger, the operations systems may buckle under the increasing scale and complexity of demand. Moreover, now there is pressure to deliver on multiple performance dimensions like quality, cost and delivery. SMEs therefore need to conceptualize and manage the transition from non-formal to formal systems for coordination of their operations. SMEs need to acquire capabilities in Operations Management and Information Technologies in order to scale up successfully.

Better Decision-making

To scale up and compete with larger enterprises, SMEs will need better decision-making that can only come from having skilled and experienced senior management. However, SMEs face serious talent crunch at the higher levels because their pay package and brand equity can not beat that of the larger players.

Role of Government: Existing policy and drawbacks

Government provides various incentives to SME units by reserving few manufacturing goods exclusively for manufacturers of SSI, through State small Industries development corporations (SSIDCS) provide raw material, Financing on concessional terms to micro and tiny units, excise duty concessions, Assistance in providing marketing support to their products and pricing preference Level Field: In India, definition of SME is based on capital investment. As most of the incentives are based on these criteria, Firms do not want to graduate from micro, tiny, SSI and medium scale. These limit the investment in up grading technology by these firms to receive the incentives. In most of the other countries like China, Indonesia, Malaysia, USA, Germany and Japan definition of SME is labour-intensive rather than capital-intensive. Distinction between one-time and continuous support: Tiny sector needs sustained support, whereas support to SMEs needs to be one-time. The one-time support can be in the form of cheap loan, land allocation, access to infrastructure. Fiscal concession beyond a certain limit acts as a dampener to growth to SME sector. There is a need for differential treatment for Urban and Rural SMEs as this should compensate the locational disadvantage. But as of now this is not taken care by Government of India Links between SMEs and Organised big players: As of now, Government is not facilitating links between SMEs and big players. Small-scale units can produce at low cost with design inputs and quality control being supplied by the large firms. Growth centres: As of now Governments assistance is at individual level, but emphasis should be developing growth centres as an agglomeration of SMEs. Other important measures initiated by the Indian government are:

1) Increase in composite loan from 2 lakh to 50 lakh 2) Lending through non-banking financial companies 3) New insurance scheme to provide security to lenders (This scheme popular in Malaysia as Credit guarantee Corporation is very successful in supporting SME)1 4) Funds through 50,000 SHGs to fund micro enterprises 5) Custom duty rationalisation 6) Increase in project limit under NEF to 50 Lakh 7) Loan limit under credit-linked capital subsidy has been raised to 1 crore for technology up gradation 9) Under SIDBIs program SME can avail funds at 2% below prime lending rate 10) Better coordination between SIDBI and commercial bank branches 11) 497 specialized SSI branches have been set up to fund SSI Two aspects of globalisation has been threatening SME survival 1) SMEs seeking to compete beyond national boundaries 2) Domestic SMEs subjected to impending competition from across the border. So SMEs should bring together their technical capabilities, integrate with capital markets and assimilate limited foreign ownership. Therefore the policy trust should be on technology upgradation, modernisation and technology oriented entrepreneurship.2

http://isb.sagepub.com/content/23/4/427.full.pdf+html A New Deal for Small and Medium Enterprises in India

Comparison of SMEs: India vs. Other developed countries

Innovation: In Japan, 50% of SMEs develop new products by combining existing technology, and overall 62% of SMEs have developed new products. This level of innovation is embedded in the policy of SMEs in Japan. Contrary to this, Indian SME policy is mostly revolved around technology development. Our SMEs depends mostly on technology transfer rather than on in-house technological innovations. Even in the latest MSMED Act 2006, there is no reference to promoting innovation. Even in country like China, to encourage innovation they have introduced The SME Innovation fund4, where evaluation is done based on technology, accounting and management of the unit. Integration of Industries: In Japan, the major industrial structure is the integration of industrial enterprises of varying sizes through subcontracting. This is the distinctive feature in Japan under which SMEs thrived. In India, SMEs are not highly integrated with big players. They mostly have informal agreements with big players and without any partnership they operate on vendor-seller relationship. It was the new product needs of major customers, which gave an immediate push to the innovations of Japanese SME whereas it is the constant touch with the customers, own perception of entrepreneurs and periodic visits to international exhibitions, which played a crucial role in the innovations of Indian SME Adaptability: In Japan, owing to extended recession, changes in global industrial structure and advances in Information technology had put SMEs in a precarious situation. But because of high integration with big players, they came up with the following strategies 1) Specialize in developing new products and new technologies 2) Implement process innovation that incorporates inventions and intellectual know-how 3) Manufacture high value products as well as develop new products as demanded by the customers. A major player guides SMEs

3
4

Nature and strategy of product innovations in SMEs M H Bala Subrahmanya http://info.worldbank.org/etools/docs/library/49274/yao2.pdf

which are integrated to it through various quality measures for example Canon helped SME Sanei to acquire ISO 14001 certification, collaboration with its employees for development of new products. Because of this mentoring from Canon, Sanei was able to stave off the threat of competition. On an average Sanei took around 6 months to come up with new product. Whereas in India, due to no formal links between industries, lack of R&D infrastructure it takes around 1 year to develop the product and another six months for approval of customers. Indian SMEs are conspicuously dependent on government for keeping off competition. Institute/University Collaboration: Institute collaboration is the major support system for SMEs in Japan. Most of the innovations that happened in SMEs received help from universities. In India, this is completely a non availability The other major inferences from this comparison are below 1) Internal capability development is crucial for long term success 2) External support is more crucial in a developing country 3) Only product innovation can sail SME through the competitive environment 4) Product innovation facilitate SME to grow in Size Conclusion: Policy related changes that affect the overall environment of doing business like financial institutions, Infrastructure, level field competition, developing a collaborative linkage between SMEs, Educational institutions and Big players plays a major role than providing direct supports like subsidies, cash discounts, tax incentives. Although there may be a case for selective interventions direct support measures are not the main role for government5. But in an imperfect market, government support partially substitute for the market to serve the role of a financial intermediary

The Role of Government in SME Development in Transition Economies David Smallbone

Do SMEs in India have the potential to become giants in next few years?
The growth of SMEs is India has come up in an uncontrolled, unplanned and haphazard manner. They are present in clustered as well as dispersed manner, in industrial, commercial and residential areas. These clusters lack reliable and infrastructural facilities such as power, road, transportation as well as good communication, information and technical inputs. They need to strengthen their competitiveness which is not an easy task. Though sometimes they perform better than their larger counterparts it is extremely difficult for them to compete with them on a bigger time frame. We strongly feel that SMEs in the current scenario are not ready to compete with the large organizations at least in the coming few years. The following reasons have been listed to support: In todays competitive world it is not only important for the organizations to provide excellent products and services but making the presence known also is an important factor. Thus it is extremely difficult for the small and medium enterprise with their limited capabilities and capacity to compete with existing large organizations to make their presence known. Branding plays a very important role which the SMEs need to realize. Another major problem that SMEs face is to find finances. It is much harder for them to borrow money from banks or to find private investors than for larger firms. Financing is necessary to help them set up and expand their operations, develop new products, and invest in new staff or production facilities. Since SMEs are usually new to the markets, and have negative cash flows and untried business models, they present a greater risk to the banks and thus the financing is much difficult for any SME which is trying to create innovative productsii. Another problem that we have identified is that SMEs does not have standard HR processes like big organizations. One reason is that it is not very economic for them to implement large

ERP solutions. But at the same time it means that they do not have enough capabilities to become world class and attract big talents. Effective management of administrative work enables HR personnel to focus on strategic and value-adding activities. Having a welldefined/structured employee database helps in streamlining transactional HR processes like payroll & employee benefits, workforce administration etc. But developing these will take a lot of time, expense and capability on the part of SMEsiii. SMEs also need to adapt to the technological changes. They need to make a lot of changes as technology plays an important part to move up the value chain and provide with business strategies to provide opportunities. SMEs need to integrate such technologies that can fuel innovation, enhance business agility, communication and information management, and merge harmoniously with existing systems and processes. Currently, there is only limited adoption of the technology by SMEs in India which makes it very difficult for them to compete with existing big organizations in the marketiv.

SMEs are facing huge competition from the international organizations. Due to globalization, the cost of transportation and communication has reduced tremendously across borders. India is a member of WTO, and thus has reduced quantitative restrictions. It is very difficult for small scale enterprises to compete with the economies of scale provided by these big organizations. There is introduction of exclusive policy for small industry but that has reduced the number of items reserved for small industry manufacturing from 842 in 1991 to 239 in 2007v.

Industry-wise analysis

S.No. Industry 1 A com uto ponents

Current Scenario 1. G overnm initiative for clusterent based developm ent 2. The industry is undergoing a m ajor restructuring and m existing any com panies are expected to m up in ove the value chain to a higher tier

A dvantages 1. Cost savings of 25%-30% w hen com pared to global peers 2. D esingning, engineering and technical skills 3. A daptability to new technology 4. A vailability of raw m aterials 5. Established quality system s

F ood processing

1. D iverse nature and a policy of SSI reservations 2. 75% of the m arket is divided betw the sm scale and the een all unorganised sectors

1, Inefficient m arketing system are s already being targeted 2. Policies are now prom oting the participation of private investors that w ould prom efficiency in food ote processing and agriculture m arketing system s

Risks 1. A global slow n can derail the dow prospects of the industry 2. Tier I m anufacturers taking up greenfield projects overseas 3. V olatility in the prices of m etals and other inputs could erode the industrys cost com petitiveness 4. Com petition fromcounterparties in other em erging countries 1. Lack of infrastructure facilities in term of s facilities for testing and research 2. Inadequate know ledge of technical standards, packaging facilities, food law s and regulations

Textiles

1. 25% of w orld cotton yarn exported fromIndia, ranked 2nd after China

2. Industrial Entrepreneurship M orandum im em s plem ented to help SM financially Es 3. M an-m textiles exports on ade decline, grow in readym garm th ade ents export 4 P harm aceutical 1. SM contribute 35% of the Es industrys turnover

1. G overnm policies designed to ent encourage investm in installing ents m odern weaving m achinery and trying to elim inating the pro-decentralised sector policy focus 2. Readym garm ade ents, benefited fromterm ination of M ulti-Fibre A rrangem ent 3. Reduction in custom duty, excise s duty and corporate tax rate

3. Quality raw m aterial supplies 4. W inform eak ation channels w regards ith to price and quality A cquisition of SM s by large organizations E seem to be the m logical step towards s ost integrating operations and building the value chain 2.Though significant investm are being ents m in the textiles segm the bulk of ade ent, themare in the spinning and w eaving segm ents 3.Fragm ented industry, face delays in custom clearance and high transportation s and input costs 1. Outsourcing opportunities are being acquired by m ainly players with better econom of scale ies

2. Increasing span of price control, 428 drugs under price control

1. D evelopm of pharm ent aceutical SEZ can support the grow of SM s th Es w hich includes availability of developed infrastructure, m arket access, exports, and excise relief 2. SM are linking up with larger Es players thus enabling clinical trials and contract m anufacturing

IT

3. The increase in average price of drugs; due to rise in prices of drugs not under control and upw revision in ard prices of certain controlled drugs ow ing to rise in input costs 1. STPI plays developm ental role in prom otion of softw exports; prim are e focus on SM Es

2. D estic industry need to invest higher om capital in R& and need to innovate due to D the introduction of product patent w hich is difficult for SM s E 3. Regulated m arket that provide better value and m argin to exporters are difficult to penetrate due to stringent regulations

2. Customapplication developm ent and IT consulting are m growth ajor drivers; Retail and distribution & banking and financial services are the m prom ost ising verticals 3. Key factors enabling the industry to achieve success; capability to provide end-to-end solutions, global delivery m odel, focus on stringent processes and quality of execution, capability to provide high-end, critical services, and strong, project m anagem ent m ethodologies and expertise

1. D recom endations; tax benefits IT m on costs incurred for goods and services procured fromdom estic SM tax deductions of up to 20 per Es, cent of incom offered to all IT e -ITeS professionals w orking w SM ith E com panies 2. Proposals to develop hardwarem anufacturing cluster parks (H CPs) M under National Electronics/IT H ardw M are anufacturing Policy 3. M ajor revenue fromthe dom estic m arket w only 35% of revenue ith com fromexports to the A Pacific ing sia region; insulated fromrupee appreciation

1. Sm IT players need to focus on all partnerships and alliances w big ith organizations to grow in a com petitive glabal scenario

2. To develop global com petitiveness, SM need to enhance technological and Es organisational capabilities

3. Industry face big shortage of m anpow er as skilled personnel m igrate to the M etros for higher m onetary benefits

Conclusion: the future of SMEs in India

The factors required for a small enterprise to grow are listed in the table below. The existing SMEs are evaluated on these parameters
Infrastructure facilities

In our country, where 77% of the population lives in rural areas, development of infrastructure plays a major role in the growth of SMEs. Many parts of the country still suffer from deplorable conditions of infrastructure like transport, telecommunication and electricity. The integration of rural industries with mainstream industries is proving to be difficult because of these reasons.
Information asymmetry

The lack of adequate information is another factor limiting the growth of SMEs in India. Information about suppliers, customers, technical information and market trends are not available at grass root levels.
Technological knowledge

Technology not only helps in evolving a multi-pronged strategy but also in maximising business opportunities for these enterprises. But, due to inadequate information flow and resources for technical growth, SMEs in India are lagging behind in growth with respect to their international counterparts.
New Product Development

In India, most SMEs work on designs given to them by domestic or international buyers. There is very little innovation happening in the product design development and even the technology being used by SMEs is outdated. Given these constraints faced by SMEs along with other challenges like low access to funds and inability to attract bright human talent, we feel that it is difficult for SMEs in India to replace the existing industrial giants in our country.

Exhibits
Exhibit 1: abbreviations
SME SSI SSIDCS SHG NEF SIDBI Small and Medium Scale Enterprise Small Scale Industry State Small Industries Development Corporations Self Help groups National Equity Fund Small Industries Development bank in India

http://www.esocialsciences.com/data/eSSResearchPapers/eSSWPArticle20091126151144.pdf http://www.oecd.org/dataoecd/53/27/37704120.pdf

ii

iii

http://www.smeworld.org/story/interviews-106/hr-management-smes-need-to-be-customerfocused-111.php
iv

http://smetimes.tradeindia.com/smetimes/editorial/2011/May/17/smes-need-to-adopt-newtechnologies625423.html
v

Small and medium enterprise: Past, present and future in India. A paper by KD Raju