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Entrepreneurship and the case for the genuine “missing middle”

By Davis Cook, CEO, RIIS

Entrepreneurship has a lot to deliver on. Long lauded as a key job creation and skills development lever in South Africa, finance minister Enoch Gondwana’s budget presentation on Wednesday, 23 February, solidified the position of entrepreneurs within the economy. The private sector, both big and small, must emerge “to grow, to access new markets, to create new products, and to hire more employees”. While not a new goal, it does further cement President Cyril Ramaphosa’s State of the Nation address last month, when he reiterated the need for small and medium enterprises, driven by entrepreneurs, to help drive job creation.

Yet entrepreneurship covers a varied spectrum of enterprise, and it becomes important to qualify where exactly the economic value might lie, when seeking to drive employment and economic growth.

Small, local businesses that typically employ five or more people and use local inputs to meet the needs of their customers, are generally referred to as “mass entrepreneurship”. With viable business models, proven profit potential and collectively high volumes, mass entrepreneurship can potentially have a significant impact on job and wealth creation.

Mass entrepreneurship is traditionally positioned as the “missing middle” between survivalist enterprise and large companies. These are companies deemed to be too big to receive start-up funding but too small for large investor consideration.

Prior to the Covid-19 pandemic, the growth rate of SMMEs was already lagging behind the targets set for the National Development Plan (NDP). A study by the Small Business Institute in 2018 indicated that while the segment was growing, it would have to grow by at least 20% per year to reach the target anticipated by the NDP, which is to contribute up to 80% of GDP growth and to generate 90% of an estimated eleven million new jobs by 2030.

There is, however, a far more missing, more genuine “middle”. This is established, mid-sized businesses, or high-growth entrepreneurs. Internationally, “midsized” businesses occupy a spectrum of sizes, from just over a hundred full-time employees, to just below one thousand full-time employees, with annual turnovers above USD 10 million. In the domestic context, this is much lower. For example, in the agricultural sector, those businesses employing just 51 to 250 employees with an annual turnover of USD 2.1 million qualify as mid-sized businesses. In the wholesale sector, turnover that qualifies a business as mid-sized can be as high as USD 13.5 million; for mining and quarrying, the turnover figure is around USD 12.9 million; and a USD 10.5 million turnover for construction and manufacturing.

For consideration as an established, mid-sized business, it is critical to have been able to successfully pass the two- to five-year business survival milestones. Compared to mass entrepreneurship, mid-sized businesses offer more reliable job creation potential. Yet they remain neglected in terms of national priority and dedicated support for scale.

These businesses bring established business models with traction; a greater level of income security through more sophisticated instruments like debt, trade credit, or cash; are subsequently significantly more resilient during downturns; tend to pay higher wages than smaller businesses; and more reliably contribute to overall productivity by providing the government a gainfully employed tax base and simultaneously reducing the number of unemployed people for whom the state must provide welfare.

The case for greater focus on assisting established, mid-sized companies is both anchored on scale and sustainability and less so pace of job creation. A Global Entrepreneurship Monitor study estimated that of South Africa’s 2.9 million entrepreneurs, 2.1 million were early stage and just 800,000 were established (Entrepreneurial Behaviour and Attitudes, 2019). (Although there remains a dearth of credible statistics on entrepreneurship in South Africa, the trend may not be massively different today.)

Given these numbers, the relatively conservative targets from key actors like government and Business for South Africa (B4SA), ranging from the creation of 300,000 to 1.5 million jobs, should not be as unattainable as they currently are. At the absolute least, just 1,200 mid-sized businesses that employ the upper boundary of 250 employees would need to realise sustainable success in order to meet the Government’s target. The questions to answer are what is difficult about this, and what would it take to make this happen?

To start, we need to identify growing, strategic sectors that are less constrained by politico-economic binds like volatile commodity prices, a declining exchange rate, the privileging of certain state-owned enterprises over private competition, and oligopolies. Strong sectors can include manufacturing (automobile, chemical, textile, and food), services (tourism, financial services, legal, communications, and transport), and energy (fossil fuel and renewables).

The next question to ask is, what established, mid-sized businesses are serving the growing needs of the particular sector well? What are the characteristics of their success that could help develop indicators of predictive success in other businesses? What would it take to get them to meet demand more consistently? This is a sharp pivot from the value chain analysis approach, where stagnant sectors are scrutinised to see what other jobs can be created within them regardless of their marginal utility or genuine relevance.

Already, some key opportunity areas apply to both domestic, export, and hybrid mid-sized businesses. First is operational support; governments need to leverage data science and market intelligence expertise to predict and plug key resilience gaps as it did with the Temporary Employer/Employee Relief Scheme (TERS) that has helped various sized businesses keep its doors open and pay employees during the pandemic. Second is bridging the digital divide to allow established mid-sized businesses to more efficiently expand their reach by leveraging technology. Access to the right basics like affordable data, hardware and software, and sufficiently skilled professionals like data scientists and software engineers – always a critical component – is now more so than ever given the digital-first paradigm shift brought on by Covid-19. Third, special development mandates are key for giving high potential mid-sized actors the necessary boost.

Fiscal incentives should be considered such as tax breaks and grant/loan facilities, favourable labour regulation updates, and protections against oligopolies in order to encourage diverse competition that is not easily pushed out of the market by large players.

For entrepreneurship to truly realise its job creation potential, South Africa must start betting on entrepreneurs with traction and reliable, predictable success; in other words, a focus on developing fewer businesses with a medium- to high likelihood of job creation success. This can offer a far more effective and efficient route than casting lots across hundreds of thousands of smaller, riskier ventures in the hope that enough of these will succeed to achieve the multiplier effect that South Africa urgently needs to make the most of its demographic dividend.