Most development practitioners subscribe to the view that vibrant small-and-medium enterprises (SMEs) are crucial for the health of a country’s economy. The SME sector is crucial, the argument goes, because it creates employment and serves as a hotbed of entrepreneurial talent. Additionally, SMEs are often seen as a source of new, fast growing industries, contributing to a price-reducing and quality-improving competition with large and old firms that tend to dominate markets in small countries such as Georgia.
For example, a 2011 report prepared for the European Investment Bank by Dalberg Global Development Advisors, bluntly states that “SMEs are a fundamental part of the economic fabric in developing countries, and they play a crucial role in furthering growth, innovation and prosperity”. If SMEs fail to perform the kind of fundamental role that is expected of them it is because, unfortunately:
… they are strongly restricted in accessing the capital that they require to grow and expand, with nearly half of SMEs in developing countries rating access to finance as a major constraint. They might not be able to access finance from local banks at all, or face strongly unfavourable lending conditions…. Banks in developing countries are in turn hampered by the lack of lender information and regulatory support to engage in SME lending. The overall result is absence of a well-functioning SME lending market, … with negative consequences for innovation, economic growth and macro-economic resilience in developing countries.”
Now, if access to funding is indeed the key binding constraint for SME development, the logical policy prescription would be to subsidize and otherwise encourage lending (or grants) to SMEs.
The “cheap loans” provided by the Georgian government for agricultural SMEs since late 2012 illustrate exactly this kind of policy response.
GEORGIAN SMES: SMALL, AND NOT GROWING
But what if funding is NOT a binding constraint (as most Georgian bankers would say in a private conversation)? What if, instead, SME development is hampered by a lack of good new business ideas or management skills?
In this case, subsidies (paid for by taxes levied on larger and more successful businesses) will result in waste. Not jobs, not innovation, not productivity gains, but waste.
For the moment, SMEs are relatively small players in the Georgian economy, even though their numbers are large. In 2012, the share of SMEs in total business turnover was only about 17%. Their share in total production value in the business sector was only slightly higher, at about 18%. Very importantly, Georgian SMEs exhibit relatively low labor productivity, especially among the smallest firms.
To understand why SMEs do not serve as an engine of Georgia’s growth, one should consider that most Georgian SMEs are engaged in a very limited range of low-productivity activities such as farming, barber shops, trade and transportation services, etc., any growth in which is ultimately self-limiting.
The self-limiting nature of SME growth becomes evident if one cares to analyze the taxi service market in Tbilisi. As more and more villagers started driving taxis in Tbilisi, taxi fares went down to a level only slightly above earnings in the low-productivity agricultural jobs, therefore reducing or completely eliminating the incentives for the arrival of new drivers (and their shoddy Ladas).
For this very reason, microfinance institutions specialized in lending to SMEs, such as (most famously) the Grameen Bank in Bangladesh, may easily become victims of their own (initial) success. Just like in the taxi example, once the number of similar enterprises hits a critical threshold, the fees they could charge collapse. The result is bankruptcy for both lenders and borrowers.
WAGER ON THE STRONG (AND LARGE)!
Thus, contrary to the established theory, it is the large Georgian firms that are mainly responsible for the creation of jobs, production of economic value, and, most certainly, exports. Moreover, the size and degree of vertical integration achieved by Georgian manufacturers turn out to be crucial for their ability to withstand competition from very large (and often subsidized) international businesses in the absence of any significant tariff or non-tariff protection.
An excellent case in point is Chirina Ltd, currently one of the largest poultry producers in the country. As reported by Simon Appleby and Eric Livny (Competitiveness of Georgian Agriculture: Investment Case Studies), Chirina represents a unique greenfield investment initiated, financed and managed Mr. Revaz Vashakidze, a prominent member of the Georgian Russian diaspora. Having earned his personal wealth in the Russian chemical industry, Mr. Vashakidze chose to repatriate a part of his fortune to Georgia in order to invest in a modern, fully integrated poultry production plant able to compete with cheap imports of frozen meat products, which had dominated the Georgian market until 2013.
Designed and built as a turnkey project by Israel’s Agrotop in 2011-2013, Chirina is a unique vertically integrated complex. Its products – fresh and frozen chicken meat sold under the BiuBiu brand – already account for about 1/6 of Georgia’s total consumption of poultry.
With a doubling of its processing capacity in early 2015, Chirina is poised to become a major food industry player in Georgia, creating hundreds of jobs, integrating Georgian agricultural producers into its supply base, applying downward pressure on prices, and expanding the range and quality of products available to Georgian consumers.
- Until recently, the company employed around 250 workers in its farming and food processing activities located Gamarjveba and Sartichala, not too far from Tbilisi. With additional broiler farms becoming operational in early 2015, Chirina was able to almost double its production and sales while significantly increasing employment.
- Crucially for Georgia’s social policy agenda, Chirina, directly contributes to the creation of many additional jobs by upstream suppliers of agricultural inputs and downstream retail partners, all of which happen to be SMEs. For example, Chirina’s marketing and sales strategy involves an exclusive partnership with a distribution company operating a large fleet of mobile retail kiosks.
- Finally, Chirina contributes to the wellbeing of Georgian consumers by bringing to the market affordable, high quality and fresh poultry meat substituting for low-quality, mass-produced frozen products imported from Turkey and Brazil.
Chirina’s example suggests that, contrary to the established development narrative, the key to Georgia’s success in technological upgrading, job creation and SME development may be held by large, well-invested food processing and manufacturing businesses. The notion that Georgia should prioritize SME development (at the expense of large enterprises) is akin to putting the cart before the horse.
Rezo Vashakidze, the owner of Chirina is quite blunt on this point. In his view, the Georgian government is using agrarian policy to achieve social policy objectives:
The current policy is to support smallholders, who are almost 50% of the population. While I understand the political significance of doing so, training and subsidizing such a large mass of subsistence farmers will inevitably lead to a waste of resources. In my opinion, the emphasis should be on medium and large business, which would integrate smaller businesses and smallholders into their supply chains or provide alternative employment in processing and services. It is unfortunate that the EU and other donors are supporting such a wrong approach.
Comments
Rezo Vashakidze's statement about 50% of the population being smallholder farmers is out of date. According to the last census, only 40% of Georgia's 3.7 million people live in the countryside, almost a million fewer than 13 years ago. Of those 1.5 million rural people, my guess is half are children under 16 or semi-retired people over 65. So that is fewer than 700,000 people of working age.
Smallholder-targeted programmes are to an extent mistakenly aimed at working-age people who have already deserted Georgia in favour of Turkey, Russia or Europe, and a few vouchers are not going to entice them to give up a GEL2500 a month cash-in-hand job in Berlin or Stockholm.
As a rule the market here is too small to attract global multinational agribusiness giants like Conagra, Cargill, Purdue, Smithfield, Noble Group, COFCO, Mitsubishi and the like. It is more interesting for (according to western standards) mid-sized family-owned companies, already well-established elsewhere and looking to invest $20-100 million here. Marussia Beverages, Schuchmanns, and Biu Biu are cases in point. They have a significant positive impact on the rural economy beyond the front gate.
There are some great rural SME's here, but in many cases their weaknesses that limit their growth (such as accounting, IT, production technology, traceability, logistics) can be adequately addressed by existing service firms here, or new market entrants from Turkey, Israel, Russia and Armenia. Government is not necessarily the answer to their problems. Paying for such services is hard, but banks and IFI's are flush with liquidity, and all complain about a lack of good proposals, so it is a soluble problem.
The point I was trying to make in this article – but perhaps failed – is NOT that Georgia does not need SMEs. My point is that the best way to support Georgian SMEs in a sustainable way is to integrate them into the supply and service chains of larger enterprises, be it Chirina in the food industry, or Magticom in computer software and electronics. The wrong approach is to indiscriminately sprinkle money on SMEs in the hope that something good will happen.
SMEs are very successful in Europe because they:
i) either complement existing large businesses by providing services (design, consulting, legal etc.,),
ii) or avoid competing with large businesses by producing carefully branded niche products (boutique wines, cheeses, etc.) that are quite competitive domestically and internationally.
The existence of a large middle class, on the other hand, creates demand for a great variety of personal services – beauty parlors, education and training, fitness, non-traditional medicine, that are best addressed by SMEs with a “human touch”.
None of these options are available in a developing country setting, such as Georgia’s.
The few large businesses that exist here have a hard time sourcing products and services from existing SMEs because the latter are very badly managed. Most businesses that tried report a lack of reliability as the key problem. (ISET tried to get a local IT company to develop a database and website for the school. What a nightmare it turned out to be! In the end, we had to engage an international company :-(.
Instead of innovating and producing niche products, as would be appropriate for SMEs, the tendency here is to copy what everybody else is already doing, resulting in the kind of disasters that were documented for Grameen’s phone ladies. Too many people doing the same things at the same time.
Georgian SMEs are also not very good at exporting (or import substitution) because they have no cost advantage when compared to larger enterprises when it comes to mass production (of, let’s say, poultry). To become internationally and domestically competitive, SMEs have to invest in unique, branded products. Not potatoes or cucumbers. Hans Gutbrot’s kiwi and honey production is a great SME, but there are very few such examples in Georgia (and if everybody follow Hans’ example his business may collapse as well).
Not all donors are aware of the issues, I think. While many talk about PPPs (targeting supply chain integration and community development), very few PPPs have actually been implemented. While offering much better sustainability prospects, PPPs are quite a bit more difficult to devise (they involve coordination with many partners), which is probably why we see so few of them getting implemented. But, one should not give up!
If I were running the EU tech assistance portfolio related to SME development, I would give huge priority to projects that 1) integrate SMEs into supply/service chains of larger producers, and 2) engage large private sector businesses in incubating truly innovative SMEs.
I would give much lower priority to microfinance or training/consulting services targeting SMEs. These are unlikely to produce sustainable results.
1. I do agree that distribution of subsidies to agriculture subsistence farmers has nothing to do with productivity growth and job creation. Most of the subsistence farmers would be eagerly employed elsewhere if there would be an opportunity; farming is not their choice. Thus, transferring knowledge to many of them is wasteful as is rightly noted. Thus, the state support for them is rather a social subsidy, which should be called this way. I expressed my position on this repeatedly for several years.
2. Some of them are indeed interested and potentially productive farmers who can grow either through vertical integration as one of the (fastest) ways, or horizontal integration (either via cooperatives, or modern clusters), if they have proper access to markets, knowledge, infrastructure and finance.
3. Vertical integration is the fastest and preferred form of growth, with technology and knowledge transfers and potential access to international markets (if involves FDI), and one of the EDA’s objectives should be promotion of internationalization. Yet, it often depends on external demand/supply and doesn’t provide fast employment. On the other hand (albeit slower, but more inclusive) Georgia may benefit from rewarding gross route entrepreneurship by assisting entrepreneurs/small businesses and farmers with improving access to markets/ finance/ infrastructure/ knowledge and helping them develop stronger value chains – this was the evolution of many leading export industries in many countries. But in this case, the provision of the support (not interest rate subsidies, but grants for knowledge transfer/technology transfer) should be done in a transparent and efficient manner rewarding productivity and innovation.
4. While Georgia currently creates most of the formal jobs through medium and large firms, it is not sufficient. Thus, parallel processes should be encouraged. In EU, vast majority of SMEs remain small (type of family businesses) in the range of 5-20 people. The difference with Georgia is the lack of diversification in the latter. The reasons – Georgian firms/entrepreneurs, while having entrepreneurial spirit and creative mind, lack: modern business processes and market knowledge, skills, access to production infrastructure and not the least important – access to finance.
Shame you did not stick to your beliefs and source that Georgian IT company....or create it! Georgian IT experts could be - given the Georgian male mind set, hellishly technical - among the finest in the world. We must be here to nurse and contribute as well as to comment and criticize, surely? In the end it is down to love of Georgia.
Economy like Georgia need incentive based subsidy beside vouchers. I dont know what biubiu thought of putting 80bln$ investment for a limited or small economy like Georgia. Big companies need raw materials like soya which is integral part of poultry feed and is a substitute for animal protein based feed. Absent of soya and corn the basic raw material will lead this company to high production cost. I think they should lay more emphasis on processing meat and export. Because in this way more small or big farmers will join hands with them by providing live animal for meat processing. I want to hear views of mr. Eric Livny in this regard. Am i right mr eric?.
Jaswinder, thanks for your question. Chirina is sourcing corn in the local market (they are contracting, on a long-term basis, a large farm in Sartichala, among other). To answer, here are a couple of quotes from our case study (http://iset-pi.ge/images/Projects_of_APRC/Case_Study_Chirina.pdf):
p. 13: "Once production commenced in summer 2013, the company was able to rely on local famers to supply its feed production plant with maize and grain. According to Keti Taktakishvili, head of Chirina’s feed production, the availability of industrial drying and storage facilities allows Chirina to buy large quantities at harvest time (at low cost) and accumulate stocks for 3-4 months of consumption. "
p. 16: "The company is generating a very strong ripple effect by exercising demand for locally produced inputs and services... The company’s annual demand for up to 20,000 tons of maize and wheat is 100 percent locally supplied through a combination Chirina-leased lands, local farmers like Sartichala-based Agromax, and smaller Georgian producers, including Indian farmers in Kakheti. Other feed ingredients are imported. This includes nutritional supplements (a major supplier is Germany-based Schaumann), soybean meal (a key source of protein in animal feed, mostly imported from Latin America), sunflower meal, soya and sunflower oil (imported from south Russia and Ukraine). ...
The symbiotic partnership between Chirina and Agromax is a great example of positive externalities translating into a virtuous circle of investment and productivity growth. The opportunity to obtain a long-term supply contract provided Sartichala-based Agromax with the incentives to invest in a new compost factory that uses Israeli technology to process Chirina’s poultry manure. Financed by an agricultural loan of 600,000GEL (subsidized by the Georgian government), the factory is now producing high quality compost, which is expected to (i) generate up to 40-50 percent increase in yields per ha ; (ii) reduce reliance on chemicals, and, (iii) save up to 800,000 GEL in the cost of fertilizer. Soso Okruashvili, the company’s CEO, is convinced that the cost of his investment will be recovered in one year.
Moreover, the symbiotic relationship between Chirina and Agromax does not stop there. Agromax is supplying Chirina not only with maize and wheat but also with straw to be used for bedding in broiler farms. Chirina’s new broiler farms are being built in Sartichala, providing steady jobs for local households, whose livelihoods have been hurt as a result of increased industrial cultivation of surrounding pasture lands. Chirina’s positive impact on local employment will thus indirectly help Sartichala-based Piet Kemp, Soso Okruashvili and Agromax in their dealings with the local community."
The point about markets becoming flooded when too many farmers jump on the bandwagon of a profitable commodity is a good one. However, the long duration between breaking ground and first harvest, and the relatively long payback period, serve as a natural barrier to entry for kiwifruit. This is also common with vineyards and orchards here due to the high cost of capital. Wild price fluctuations due to a lemming-like stampede of farmers into a crop that received a good price the previous season is much more pronounced in annual crops, like potato, onion and garlic.
Also, in 2013 the EU imported over USD$300 million worth of kiwifruit (215,124 tonnes) and it would take over 7000 Ha of mature kiwifruit plantation operating at international norms of productivity to meet that demand. Total Georgian production is no more than 0.5% of that import figure at present. I think Hans and Kote's market is safe for the time being
The current drive for domestic rural SME enablement , through cheap loans for SME's, as well as land grants to domestic companies for very low prices (as low as USD60/Ha) , is driven as much by economic nationalism as anything else. There is a strong sense that it is better for food processing and production to be fragmented and small-scale, as long as it stays out of foreign hands. Ultimately such businesses will not be able to support the high cost of ever more draconian EU food safety regulations on such a small turnover, they will close and Georgia will possibly import even more food than it does now.