Kenyan SMEs Set To Outperform

BMI View: Small and medium enterprises (SMEs) face challenges across Sub-Saharan Africa, but those in Kenya are better placed than most to grow and succeed. An improving business environment, a technologically adept population, and established trade links with key export markets will help SME growth.

Small and medium enterprises (SMEs) such as restaurants, commercial farms, and small traders are leading employers in Sub-Saharan Africa (SSA) and their continued success will be crucial in ensuring inclusive growth across the region. In most countries, however, difficult business environments, poor infrastructure, and a crippling shortage of credit hamper the growth of small firms. This is one reason why breakneck GDP growth has done so little to tackle Africa's huge levels of unemployment and underemployment.

BMI highlights Kenya as an outperformer, believing that the country's improving business environment, technologically adept population, and established trade links with key export markets will help boost SME growth. Kenyan firms will still face serious challenges, but they are better placed to succeed than most of their SSA peers.

Small Firms and Informal Sector Provide Most Employment
Kenya - Working-Age Population By Employment, mn

Kenyan SMEs Set To Outperform

BMI View: Small and medium enterprises (SMEs) face challenges across Sub-Saharan Africa, but those in Kenya are better placed than most to grow and succeed. An improving business environment, a technologically adept population, and established trade links with key export markets will help SME growth.

Small and medium enterprises (SMEs) such as restaurants, commercial farms, and small traders are leading employers in Sub-Saharan Africa (SSA) and their continued success will be crucial in ensuring inclusive growth across the region. In most countries, however, difficult business environments, poor infrastructure, and a crippling shortage of credit hamper the growth of small firms. This is one reason why breakneck GDP growth has done so little to tackle Africa's huge levels of unemployment and underemployment.

BMI highlights Kenya as an outperformer, believing that the country's improving business environment, technologically adept population, and established trade links with key export markets will help boost SME growth. Kenyan firms will still face serious challenges, but they are better placed to succeed than most of their SSA peers.

Small Firms, Huge Potential

The informal nature of most SMEs means that precise estimates of their economic importance to the Kenyan economy vary, but it is widely estimated that between 75% and 85% of Kenyan workers were employed by family enterprises and SMEs. Many of these are subsistence farms rather than commercial operations, but the 2009 census reported that 13.1% of the working-age population was self-employed outside of the farming sector and that 15% was in the informal wage sector. These figures are unlikely to have substantially changed, making SMEs a key determinant of employment and private consumption in the country.

Small Firms and Informal Sector Provide Most Employment
Kenya - Working-Age Population By Employment, mn

The employment-creating impact of SMEs is especially important given the lack of jobs in the formal sector, which employs just 9.7% of Kenya's 20mn workers. Accelerating economic growth is doing little to change this: the World Bank reports that Kenya's economy creates just 50,000 formal jobs each year, while the working-age population balloons by 800,000.

Job Growth Needed
Kenya - Population By Age Group, mn

This challenge will become increasingly acute over the coming years as the country's working-age population expands. In 1990 Kenya had more children below the age of 15 than working-age adults, but between 2000 and 2030 the number of potential workers will increase by 23mn. The successful growth of SMEs, many of them informal, will be crucial if Kenya is to maintain employment growth and social cohesion.

Beyond the number of jobs created, SMEs also play a role in increasing the population's skill level and improving economic output. Moving workers from inefficient family farms to flower-cutting operations, small shops, and local trading firms increases productivity and boosts income. In some sectors, such as Nairobi's growing information and communications technology industry, SMEs provide valuable training and help to develop value-added exports.

An Opportunity Often Squandered

Kenya's sometimes difficult business environment imposes costs on all firms active in the country, but smaller SMEs are especially vulnerable. We highlight poor physical infrastructure, government corruption, and a lack of access to credit as key obstacles to the growth of Kenyan SMEs.

Power outages frequently force work stoppages and transport disruptions force Kenyan firms to hold large inventories of their key inputs. This increases costs and lowers profits, especially for cash-poor smaller firms that struggle to afford costly generators. A lack of potable water has been identified by the government as a key obstacle to growth in many sectors.

Government corruption places a heavy burden on SMEs, which are often forced to pay expensive bribes. Small business owners and single traders lack the political connections that often help larger enterprises to get government contracts and avoid legal disputes.

Obstacles To Lending
Africa - Obstacles Preventing Banks From Lending To SMEs, % Of Respondents

Perhaps the largest obstacle to SME growth, in Kenya as across Africa, is a lack of access to credit. A World Bank survey published in 2013 reported that 70% of Kenyan banks regard macroeconomic factors as a key obstacle to SME lending, while 38% cited the legal framework that regulates SMEs. The fact that small firms often use informal accounting methods and seldom have a credit history deters many potential lenders. Most local banks prefer to deal with established blue chip firms, leaving SMEs reliant on informal lenders. Just 17.4% of Kenyan bank loans are extended to SMEs, despite the fact that these firms make up the majority of the market. The expansion of credit reference bureaux (which currently cover just 4.9% of Kenyans) will help to slowly address this problem.

This lack of credit prevents traders from sourcing goods in bulk, commercial farmers from buying productivity-boosting fertilisers, and shops from expanding into new markets. Access to credit is a problem even for Nairobi's fast-growing technology sector, one of SSA's best developed. A survey carried out by the GSM Association found that 60% of Kenyan technology start-ups are entirely self-funded; just 2% receive money from angel investors, compared with 37% in the American technology industry.

Small Can Still Be Beautiful

Despite these obstacles, BMI still highlights Kenya as an outperformer, believing that SMEs there offer better prospects than those in most other SSA countries. They key reasons for this are an improving business environment, a technologically adept population, and established trade links with key markets.

Kenya's business environment is improving owing to both physical infrastructure improvements and better policy. Its power infrastructure is already better than that of regional peers such as Nigeria and Zambia, and will continue to improve (see 'Africa Competitive Landscape: Slowly Unbundling Its Power Potential, June 30). We doubt that the ambitious power generation targets published in the government's Vision 2030 plan will be met, but believe that Kenya's renewable energy potential will boost output. The use of decentralised solar power generation will also bring electrification to small towns and villages.

Government policies are another reason for optimism. The 2012 Micro and Small Enterprise Act will aid access to credit by encouraging the official registration of small firms and enforcing basic accounting standards. The new Micro and Small Enterprise Authority (MSEA) will coordinate government policy and provide valuable training. Implementation will be slow, however, and policymakers seeking to help SMEs should be wary of weighing them down with unnecessary red tape. While corruption will remain a key concern, we believe that the expansion of the president's e-governance initiatives will provide more opportunities for SMEs to report mistreatment.

The second key driver of Kenyan SME outperformance will be the country's use of mobile technology, especially mobile payments. Cash-transfer services such as mPesa - which is used by more than 70% of Kenyans - allow small firms to pay suppliers, store money, and accept payment for services. The use of such services is helping firms develop a credit history, and will speed their integration into the banking system.

Kenyan tech start-ups are capitalising on this widespread use of mobile money to launch a dizzying array of mobile applications and digital services, turning Nairobi's Ngong road into one of Africa's technology centres. These web-focused SMEs are creating a value-added industry that provides highly paid jobs, and helps to diversify the economy. This high-tech cluster has already drawn in investment from IBM and Google, establishing economies of scale that many believe pose a threat to South Africa's regional dominance of the technology industry.

Finally, BMI believes that Kenya's close trade links - both with East Africa and Europe - will help local SMEs to grow by capturing larger markets and establishing economies of scale. Many small firms are already active in the country's horticulture and vegetable sector, exporting high-value goods to Europe and the Middle East. This has allowed local farmers to boost their income and created a regional cluster of agro-processing SMEs. Transport infrastructure remains a key concern, but Kenyan firms are better placed than East African rivals to access both regional and global markets.

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