Factors for Small Business Failure in Developing Countries
INTRODUCTION
Small and Medium Enterprises (SMEs) play a pivotal role in the economies of numerous countries, especially in those that are still in the development phase. SMEs constitute the majority of businesses worldwide and serve as significant contributors to both job creation, poverty alleviation and the overall advancement of the global economy. They make up roughly 90% of all businesses globally and play a substantial role in generating employment opportunities, accounting for more than 50% of the global workforce.
Formal SMEs alone contribute as much as 40% of the national income (GDP) in emerging economies, and this contribution increases even further when informal SMEs are taken into account. When considering the future, projections suggest that approximately 600 million jobs will be necessary by 2030 to accommodate the expanding global workforce, according to World Bank.
However, despite their potential, these enterprises often face a high rate of failure. An article by Business Day Nigeria shows that “80% of businesses in Africa fail within their first five years of existence”. This article explores the critical factors that contribute to small business failure in developing countries, accompanied by key statistics to shed light on the extent of the problem.
FACTORS THAT CONTRIBUTE TO SMALL BUSINESS FAILURE
Limited Access to Capital
According to the International Finance Corporation (IFC), around 70% of small and medium-sized enterprises (SMEs) in developing countries have no access to formal financial services.
Access to capital is a pervasive issue for small businesses in developing countries. Lack of access to credit, high interest rates, and stringent lending criteria limit entrepreneurs' ability to secure the funds needed for business operations and expansion. As a result, many businesses struggle to cover initial startup costs or navigate unforeseen financial challenges.
Inadequate Market Research
A study by the World Bank found that over 50% of small businesses in developing countries fail due to a lack of understanding of their target market and customer needs.
Insufficient market research is a common pitfall for entrepreneurs in developing countries. Without a comprehensive understanding of local market conditions, consumer preferences, and competitive landscapes, businesses often develop products or services that do not resonate with their target audience. This leads to low demand, sluggish sales, and eventual failure.
Regulatory and Legal Barriers
According to the World Bank's Ease of Doing Business Index, many developing countries rank low in terms of ease of starting and operating a business. Compliance with government regulations often requires significant time and resources. Navigating complex and inconsistent regulatory environments can be a formidable challenge for small businesses. Entrepreneurs may struggle to obtain licenses, permits, and adhere to various regulatory requirements, diverting valuable resources away from business growth. This issue is particularly pronounced in countries with high bureaucratic red tape.
Infrastructure Challenges
The World Bank estimates that inadequate infrastructure in developing countries can reduce a business's productivity by up to 40%.
Deficient infrastructure, including unreliable electricity, poor transportation networks, and limited access to the internet, disrupts daily business operations and increases costs. Frequent power outages, transportation delays, and difficulties in conducting online transactions hinder productivity and competitiveness.
Limited Access to Technology
The United Nations Conference on Trade and Development (UNCTAD) reports that the digital divide remains significant, with around 46% of the world's population lacking internet access.
Access to modern technology is a critical determinant of small business success in the digital age. Unfortunately, many entrepreneurs in developing countries lack affordable and up-to-date technology, limiting their ability to compete, innovate, and reach a broader customer base.
Lack of a Skilled Workforce
A report by the World Economic Forum suggests that 70% of employers in developing countries face challenges in finding employees with the necessary skills.
A shortage of skilled workers is a common impediment to small business growth in developing countries. Businesses often struggle to recruit employees with the required skills and qualifications, which can hamper productivity and expansion. Moreover, limited access to education and training programs perpetuates this skills gap.
Economic Instability
Developing countries often experience economic volatility, with fluctuating exchange rates and high inflation rates. For example, some countries have seen annual inflation rates exceeding 50%.
Economic instability, characterized by currency fluctuations, inflation, and overall volatility, can disrupt small business operations. Unpredictable exchange rates affect the cost of imports and exports, while high inflation rates erode consumers' purchasing power, affecting demand for goods and services.
Cultural and Societal Factors
A study by the Global Entrepreneurship Monitor (GEM) found that cultural attitudes towards entrepreneurship vary widely across developing countries, with some societies showing a greater preference for traditional employment.
Cultural norms and societal attitudes toward entrepreneurship can influence small business success. In some developing countries, there may be a preference for stable, traditional employment, while a fear of failure or societal expectations discourages individuals from pursuing entrepreneurial endeavors.
Intense Competition
According to a report by the International Trade Centre (ITC), small businesses in developing countries often face competition from both domestic and international players.
Intense competition is a double-edged sword for small businesses. While competition can drive innovation and improve products and services, it can also lead to price wars and reduced profit margins. Small businesses may struggle to differentiate themselves and capture a significant market share.
Vulnerability to External Shocks
The Centre for Research on the Epidemiology of Disasters (CRED) reports that developing countries are disproportionately affected by natural disasters, accounting for the majority of disaster-related fatalities.
Small businesses in developing countries are often more vulnerable to external shocks, such as natural disasters, political instability, and global economic downturns. These events can disrupt supply chains, damage infrastructure, and negatively impact consumer confidence, leading to business closures and financial distress.
CONCLUSION
Small business failure in developing countries is a multifaceted challenge with profound economic and social implications. The factors discussed in this article—limited access to capital, inadequate market research, regulatory barriers, infrastructure challenges, limited technology access, skills gaps, economic instability, intense competition, vulnerability to external shocks, and cultural factors—contribute to the high rate of small business failures in these regions.
To address this issue, governments, financial institutions, development organizations, and the private sector must collaborate to create an enabling environment for small business growth. This includes facilitating access to finance, streamlining regulations, improving infrastructure, investing in education and skills development, and promoting a culture of entrepreneurship. By tackling these challenges head-on, developing countries can unlock the potential of small businesses as engines of economic growth and poverty reduction.
