Title: Characteristics of Better-Performing Nepali SMEs and Implications for Policy

Author: Mushtaq Khan, Siddartha Mainali, Saumitra Neupane, Shreeya Rana, Pallavi Roy, and Aslesh Shrestha

Year of Publication: 2022

Executive Summary

The constraints facing Nepali SMEs are well known, but most of these constraints will take time to address. In the meantime, higher-growth Nepali SMEs demonstrate that it is possible to achieve better performance within the current business environment. We look for characteristics distinguishing better-performing SMEs from others as a way of informing policies that are likely to be immediately effective in improving SME performance. It does not follow, of course, that the capabilities associated with better performance are necessarily the cause of this better performance. However, since these are plausible determinants of performance, the associations we find suggest plausible entry points for trialling feasible interventions to improve SME performance. The results of smaller-scale trials focusing on specific knowledge and capability transfer strategies could then be assessed for their causal effects, and the most effective types of support scaled up. Reforms addressing the business environment may become easier if a larger number of better-performing businesses emerge and help to identify and demand the most feasible and appropriate systemic changes.

We surveyed 352 SMEs in Bagmati, Madhesh, Lumbini, and Karnali, involving 274 small and 78 medium-sized firms, 106 in agro-based industries, 112 in tourism-related services, and 134 in light manufacturing. We looked at a wide range of characteristics that are plausibly important for SME performance and identified the ones that were significantly correlated with better-performing SMEs. Better performance was defined by an above-average employment growth rate and export success. Capability characteristics looked at included a range of organizational, technical, and marketing capabilities, learning by doing, investments in buying in consultants and marketing advice, access to finance, the type of market the SME operated in, and access to different types of politicians. The results of our analysis of correlations between capability characteristics and SME performance provide new evidence on Nepali SMEs and can be used to inform experimental policy trials prior to scaling up.

1. Setting up firms with good organizational and technical knowledge at the outset was the characteristic most strongly associated with both higher growth and export success. Better-performing SMEs were more likely to employ personnel from successful firms marketing similar products while being set up and more likely to have owners with experience of working in successful firms. Support for SMEs should seek to provide organizational and technical support at the time firms are set up using personnel with direct experience of working in a similar type of SME. This is more challenging than the provision of general business support services, but we find little evidence of general business services being associated with success.

2. Investments in skills training have mixed associations with better performance, being associated with better performance in some groups of firms and not others. Evidence from other countries shows that skills training is only likely to raise competitiveness if a firm already has sufficient organizational capabilities to use skills profitably. Our field research shows that the most important types of technical skills required by SMEs involve tacit knowledge (practical know-how) of actual processes, and these too are best supplied by personnel from other SMEs with practical knowledge of relevant processes. As with organizational knowledge, tacit knowledge is best transferred by personnel with direct work experience in successful SMEs delivering the same product or service.

3. Higher-growth Nepali SMEs are more likely to have market power because their products or services are hard to copy. This is not necessarily a problem for already existing SMEs, but for Nepal to break into broader markets requires strategies for raising the competitiveness of firms providing standardized products and services. This includes the tourist industry where Nepal needs to increasingly draw tourists who are not already committed to visiting Nepal. This is likely to involve matching or improving upon the price and quality offered by regional competitors in tourism.

4. Access to finance too was associated with better performance in some groups of firms but not others. Initial access to loans and subsequent access to working capital was associated with higher growth in the pooled sample of firms and in small firms, but not in medium-sized firms. From a policy perspective, combining access to finance with effective strategies for improving organizational capabilities and skills is likely to be necessary.

5. Finally, the political access of SMEs to local and provincial government officials was significantly associated with higher growth. Developing the provincial government’s capabilities for coordinating support to SMEs could be an important way of working in alignment with already existing SME demands for information and support from the provincial government. Despite the small number of exporting firms in our survey, we identify a few characteristics that distinguished exporting firms from others.

6. The prior experience of owners working in successful firms was again strongly associated with export success. This again highlights the importance of setting up a firm with strong organizational capabilities.

7. Access to preferential (government incentive-backed) loans was a very important distinguishing characteristic of almost every category of export-oriented firms. This is not the case with higher-growth firms in general. The most likely interpretation of this is that Nepali exporters are not yet sufficiently competitive and need different types of subsidies to offset lower productivity, and other systemic disadvantages like high input and transport costs, and so on. Further research on the prices and qualities of exporting firms is necessary to determine how important access to subsidies is for export success.

8. Customer input for improving product quality was a significant characteristic of exporting firms, but not in the average high-growth firm. Buyer/customer/OEM engagement with suppliers is one of the productivity-enhancing advantages of insertion into global value chains. But most Nepali SMEs will first need support to develop the capabilities and competitiveness to enter exporting value chains in the first place.