Micro firms have big role to play in creating jobs and poverty reduction

You can spot them all across China in different shapes and sizes, ranging from small restaurants, hair salons and shops to a host of enterprises that make a variety of goods. Though these micro and small enterprises have been largely inconspicuous, they are often the essential springboard for growth, job creation and social progress.

Small and medium-sized enterprises in China have not exactly been in the pink of health. Issues such as funding concerns and inadequate government support continue to be a major constraint for many of the SMEs, thereby restricting their room for growth. However, a great deal of progress has been made.

According to data provided by the SME division of the Ministry of Industry and Information Technology, there were 13.7 million registered companies and 40.6 million self-employed companies in China last year. More than 99 percent of them were medium and small to micro-sized companies, contributing more than 60 percent of the annual GDP, and more than 80 percent of the jobs in cities.

In government parlance, SMEs are often referred to as the “cells of the economy”. That definition is more than justifiable considering that a huge economy often consists of thousands of cells that are small and invisible and often not given too much attention in our daily lives.

Integral element

Jerry Mao, partner of the Shanghai-based Lunar Capital, a China-focused private equity fund that has been investing in small enterprises for some time, feels that SMEs are an integral part of the Chinese economy.

According to Mao, though small enterprises are more vulnerable to the economic environment, “once they are on the right track, they can offer much more impressive growth rates”.

“Annual growth rates of more than 10 percent are almost impossible for most multinationals, but it is highly possible for SMEs,” he says.

During the last three years, Mao's company has made investments to the tune of more than $100 million in Chinese SMEs. The SMEs Mao's company normally selects for investments are mostly niche players. Citing an example, he says his company recently invested in a Guangdong-based maternity dress-maker, which enjoyed a good reputation among moms-to-be.

Though the turnover of the company was nowhere near big textile companies, Mao says he was motivated to invest in the firm due to its niche status.

“The good thing about SMEs is that most of them are involved in making products like clothing and food that people need for their daily lives. So there is no big fluctuation like in the energy or ore industries.”

Gao Xudong, deputy director of the Tsinghua University Research Center for Technological Innovation, says that in recent years the government has been focusing more on SMEs, as was seen during the 18th Party Congress last year.

“Apart from that, we have many industrial and innovation parks in China providing safe harbor for start-ups, as well as incubators with favorable land and tax policies to protect SMEs that are still in their infancy.”

SMEs are not only major participants in traditional industries, but also becoming increasingly active in emerging industries and modern service industries, say officials from the SME division of the Ministry of Industry and Information Technology.

Zhao Jiamin is one of the several SME entrepreneurs in China involved in emerging industries. Though he could have enjoyed a high salary and a good welfare package with tech major Oracle in the United States, he decided to come back to China in 2007 to start his own business – Yeeyan, a website that translates foreign content into Chinese.

As a young entrepreneur who started his business both in the US and in China, Zhao says start-ups actually have a better chance to stand out in China.

“I tried to start a business in the US, but as a foreigner I had to meet many requirements including getting a working visa. I could not afford to lock myself in the garage for many years to come up with a hit product as many American dreams describe.”

Zhao says his decision to move back to China was based on his excellent networks in China, lower living costs, and inexpensive, high-quality talent. His company employs more than 30 people, including eight overseas returnees with impressive resumes. Though it is yet to break even, its revenue has grown steadily. Last year, company revenue reached 2 million yuan ($376,336).

Growing pains

Economists usually describe SMEs as flexible, using a metaphor that says “small boats easily turn direction”. But very often the “small boats sink easily when storms hit”.

“We are very flexible but extremely vulnerable,” says Ge Xuan, a media company manager and the owner of a small liquor trading company. Ge is a typical micro-entrepreneur who not only identifies investment opportunities but also tests the waters. When he found out about the high margins for baijiu (Chinese liquor) and imported red wines two years ago, he quickly started a liquor trading business and made his fortune.

However, this year Ge's liquor business is languishing. With the new government determined to cap luxury goods consumption by officials, especially of high-end spirits, his baijiu business has fallen 70 percent. The Moutai he sold used to have a price tag of 2,300 yuan a bottle earlier, but is now selling for 850 yuan.

While applauding the policy because it beats corruption, Ge says he has to struggle to make ends meet solely with revenue from red wine, which is still popular with the public.

With economic prospects still gloomy, Ge's media company has also felt the chill. The media company he worked in used to enjoy profit margins of 50 to 70 percent by helping automakers place advertisements in newspapers and magazines. This year, the profit margins have fallen to nearly 30 percent.

“Automakers used to have a big budget for advertising when the market was good. But this year they are extremely cautious and are choosing only niche media due to financial constraints,” Ge says.

High tax rates are another bugbear for most of the SMEs in China. The current value-added tax rate is 17 percent, making it impossible for many businesses to earn profits.

In places like Wenzhou, Zhejiang province, home to many shoemakers, the average profit margin has slumped to below 3 percent.

But the future is not all that bleak for SMEs in China. Gao Xudong from Tsinghua University says most SMEs are involved in consumer products, so can expect a silver lining as the government is encouraging domestic consumption.

“Exports and an investment-driven economy have proved to be unsustainable in the long run. So the government has turned to consumption for future development. This is definitely good news for SMEs,” Gao says.

However, many SMEs feel they are often pushed around by the bigger firms. Zhao says he often faces pressure from upstream and downstream companies in his line of business.

His company works mostly with publishing houses to translate novels or science books. “The publishers often tend to squeeze our profits, rather than treat us as equal business partners.”

The SMEs also feel that academic institutions are not really supportive of their efforts to work on emerging technologies. Since many SMEs lack the talent or money to invest in research projects, they turn to institutes or universities for help. However, projects floated by the SMEs are usually specific, unlike those of state companies, so many institutes are reluctant to devote time or resources to such projects.

“It's hard to approach academic institutions,” says a gas-meter manufacturer based in Wenzhou on condition of anonymity. “They either raise tough requirements for patents, or charge us a lot of money. I really hope they can serve society more by joining hands with us.”

According to a World Bank report last year, China's state-owned companies receive massive loans thanks to state ownership of banks. Nearly 25 percent of these firms are in the red, and have an average productivity growth rate two-thirds lower than that of private firms.

Financial strain

SMEs are not so lucky when it comes to financing. Mao of Lunar Capital, who also invests in China-related projects in Italy, says unlike Italian banks, Chinese banks are not too keen on providing financial support to SMEs.

“Many of the SMEs we worked with had failed to get financing from Chinese lenders. The banks tend to ask land mortgage as collateral, something that most of the SMEs cannot provide,” says Mao.

Zheng Jiansheng is a typical case in this regard. He owns a gas meter company and last year its sales in domestic and overseas markets reached 100 million yuan.

Over the past few years, the company has exported gas meters to Europe, North America and the Middle East, and Zheng made quite a fortune from that. Now he is considering taking a further step: to acquire some companies in these mature markets to avoid the high logistics costs and other tariffs.

“The financial crisis has affected many European meter manufacturers. Most of them have quality products and the required certification to sell in Europe, and are keen on getting more capital from China.”

Though the European bargains are tempting for micro entrepreneurs like Zheng, there are also several financial hurdles. Zheng recalls a recent incident that depressed him. During an investment summit he saw several North American gas supply companies on sale at a very low price, but when he paid visits to major Chinese banks for financing, they all turned him down.

“It is almost impossible to buy these companies by ourselves, as we don't have that much cash. Chinese banks don't support overseas mergers and acquisitions by SMEs as they feel 'it is too risky' or 'there are no government policies' for such cases.”

The complicated and prolonged procedures required for getting financing for domestic business operations have also affected many SMEs.

Most of the time it requires dozens of stamps and months of long waiting to get the required paperwork done. As a result, companies that urgently need money often seek quick loans from usurers.

In Zheng's hometown Wenzhou, the city that has the largest number of SMEs, this option is very common. “It's quick and simple, although we have to pay high interest rates,” Zheng says.

But once the capital chain breaks down, the result can be fatal. In the past two years, hundreds of business owners have fled, as they were unable to repay the loans.

This financial pressure is directly related to the transformation of China's economy, says Gao from Tsinghua University. “A decade ago the economy was so good that by just exporting T-shirts companies could make a fortune. But overseas demand has dropped since then and domestic competition intensified. So SMEs have to change their development route and add more value to their products, so that they have better chances of securing financing from banks.”

Lending solutions

Though the Nobel Prize winner Mohammed Yunus of Bangladesh started the micro credit mechanism more than 30 years ago, it has taken root in China only recently. Bai Chengyu, secretary-general of the China Association of Microfinance, says China is at least 20 years behind India in terms of micro credit. “In many countries such as Bangladesh, it has become a large-scale industry, but in China, it has just started.”

Tang Ning was one of the early entrepreneurs who realized the potential of SME financing. After working in Wall Street for several years, he returned and started CreditEase, a company that gives loans to SMEs.

Tang says his company often searches for the tiniest of clients, be it villagers borrowing money to raise chickens, or barbershops in the back street and even restaurants making noodles or dumplings. “This is a business that no bank would ever consider doing,” he says.