A Blueprint For The Evolution Of The SME Sector In The Middle East With technological change occurring exponentially, the revolution puts innovation at the heart of national competitive advantage. GCC countries will need a new wave of capable SMEs to stay relevant to this new ecosystem.
By Ahmad Khamis
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It's no secret that SMEs are powerful drivers of economy, industry and employment throughout the GCC, and the MENA region as well. And their economic contribution is becoming more essential through a confluence of three factors– large, young, national populations seeking gainful employment; a drop in oil prices hurting government revenues; and the onset of the fourth industrial revolution, where nation states are gaining competitive advantages through investments in technology, innovation and IT, as conventional relationships between citizen, state and economy are renegotiated.
In the MENA region, some 40% of the population is under 25 years old. Apart from expatriate workers, GCC countries host a large percentage of young nationals who need to be inculcated effectively into the economic narrative. With public sector job creation plateauing, SMEs will compose the next wave of employment opportunities. The lower price of oil has had a significant impact on GCC countries, given that they have historically derived 80% of all government revenues from petrochemical sources. IMF figures show that export revenues for GCC countries fell by around US$275 billion in 2015 due to lower prices. A way of offsetting this shortfall is by building up the SME sector to be more innovative, productive and adding economic value.
At the same time, the World Economic Forum has defined the fourth industrial revolution as "…a fusion of technologies that is blurring the lines between the physical, digital, and biological spheres." With technological change occurring exponentially, the revolution puts innovation at the heart of national competitive advantage. GCC countries will need a new wave of capable SMEs to stay relevant to this new ecosystem.
Why SMEs matter today
94% of all companies in the UAE are SMEs. Together, they contribute 30% of the country's GDP, and employ 72% of the country's working population. SMEs operate extensively throughout the rest of the GCC too. 90% of all companies in Kuwait, Oman and KSA are SMEs, while the Qatari business ecosystem is 75% composed of SMEs. They employ 60% of Saudi Arabia's workforce, 43% of Oman's, 57% of Bahrain's, 23% of Kuwait's, and 20% of Qatar's.
Collectively, these SMEs and the people they employ are crucial to economic growth in GCC countries. Our research at Bloovo.com shows that SME activity accounts for 30% of the UAE's GDP, 28% of Bahrain's, and 22% of KSA's. Kuwait's GDP is 20% composed of SME activity, with Oman's GDP relying on SMEs for 17% of its total. In terms of absolute numbers, the latest available numbers show that there are around 350,000 SMEs operating in the UAE, some 670,000 in Saudi Arabia, 30,881 in Qatar, 27,000 in Kuwait and 29,600 in Bahrain, and 13,741 in Oman.
While SMEs are largely associated with service provision, Bloovo.com's research shows them also playing a very important role in boosting GCC manufacturing capabilities. 2014 data from the Gulf Organization for Industrial Consulting (GOIC) shows 13,480 small and medium sized factories in operation, of which 10,809 were small- and 2,671 were medium-sized. Collectively that year, they accounted for a staggering 82.7% of the total number of factories in the GCC, and also employed 44.1% of the total industrial sector workforce despite the small investment size.
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Employing future generations
SMEs already employ around 17 million people across the GCC, with that number heading towards the 20 million mark by 2020– a healthy growth of 2.5%. But that's only the middle of the road scenario: a more optimistic scenario (where governments, regulators and innovation drivers align) could take that figure to 22 million. Some 3.4 million people in the UAE are employed directly by SMEs. Around 9.5 million people in Saudi Arabia also benefit from SME-generated employment. Kuwait has around 0.6 million people employed by SMEs, Oman has 0.8 million, Bahrain has 0.4 million, and Qatar 0.3 million. SMEs' capability to generate jobs is crucial not just for economic progress but also social stability. With GCC population growth rates ranging between 0.5% (UAE) and 8.1% (Oman), and around 40% of the population being under the age of 25, thousands of young GCC nationals are expected to be looking for gainful employment every year. It's important for long-term security and sustainability that nationals be meaningfully integrated into economic productivity.
However, top-down nationalization has its limitations. In an era of tighter budgets and increasing populations, government jobs aren't plentiful. Yet nationalization in the private sector has proved elusive, with most nationals preferring the prestige and perks that come from public sector employment. With government sector employment reaching saturation, SMEs will play a crucial role in generating rewarding job opportunities that are innovative enough to attract national talent, and challenging enough for skill-building. But for SMEs to take center stage in generating viable employment opportunities that can attract young national talent throughout the GCC, they're going to have to overcome some significant challenges that limit their ability to innovate and scale up.
Systemic challenges
It's easy enough to establish that SMEs are a crucial component for sustainable economic growth in the GCC post the oil price decline. Not only do they contribute very significantly to GDP, they also generate high job numbers. But they are confronted by substantial and systemic barriers to growth, including a lack of credit support- which is partly the reason they still don't have the same economic significance, or play the same role, as their counterparts in the EU, for instance.
SMEs suffer a lack of credit lines, with banks in the GCC unwilling to lend to smaller concerns at a time of squeezed liquidity. Bloovo.com shows that finance rejection rates run as high as 75% for most GCC countries. Only 2% of total bank lending across the GCC goes to SMEs. Meanwhile, bankruptcy laws either don't exist or are harsh. Funding challenges are a big constraint for SMEs. They find it very difficult to raise conventional debt-based finance due to risk-aversion on the part of lenders. There is also no way to fail safely because of financial laws. Other challenges include a difficult business environment caused by poor ease of doing business rankings in many GCC countries, slower than expected reforms in regulation and legislation, and a lack of emphasis on modernizing the GCC education sector to produce the talent needed to create knowledge workers. A lack of research, data and reports also hampers effective decision-making.
The transition to a knowledge economy
GCC SMEs are going to be impacted by the fourth industrial revolution, or Industry 4.0, whether they are ready or not. While the jury is still out on what Industry 4.0 entails, consensus is emerging around a potential renegotiation of the relationships between producers, consumers, governments and citizens. This renegotiation will change how services are offered and consumed, and will be driven by big data capabilities and the Internet of Things (IoT) where more and more devices are able to communicate with one another– and with human users. Bloovo.com's research shows there isn't just room for SMEs to grow in scale, but also to become smarter and more innovative. Advanced data capabilities and artificial intelligence are bringing back the concept of the knowledge worker, and favoring technologically innovative economies over traditional manufacturing ones. Bloovo.com's research treats the World Economic Forum's (WEF's) Global Competitive Index as a proxy for the innovation-centricity of GCC economies. And while Switzerland, Singapore and the United States lead the CGI charts, the first GCC country (Qatar) comes in at 14th. Qatar is followed by the UAE at 17th. Saudi Arabia is 25th and Kuwait 34th, with Bahrain and Oman coming in at 39th and 62nd respectively.
While Qatar leads the GCC across a number of innovation variables –thanks partly to a clearly defined national research strategy– R&D expenditure remains worryingly low across the GCC when compared with international peers. Germany allocates 2.85% of its GDP to R&D, while the USA earmarks 2.81%. In comparison, the UAE leads the GCC by investing 0.49% of its GDP in R&D, followed by Qatar, which sets aside 0.47%. For SMEs to cope with Industry 4.0 while generating the innovation and viable employment opportunities, the order of the day is to upgrade the entire SME ecosystem– supported by technology acquisition, application oriented R&D, skilled workforce development, favorable regulations and a strong intellectual property regime.
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The way forward
Despite challenges along the way, Bloovo.com research shows that GCC countries are aware of the importance of creating an effective SME ecosystem, and have been implementing support measures for some time now. Bahrain was the first GCC country to actively acknowledge the importance of SMEs in 2006 by setting up the Tamkeen body to support the sector. Qatar followed in 2011 with its Enterprise Qatar support body. Oman established its SME Develop ment Fund in 2012 to deliver subsidized finances, training and mentoring for SMEs. In 2013, Kuwait established a $7 billion National Fund for Small and Medium Enterprise Development from government coffers. More recently, Saudi Arabia has formed its Public Authority for Small and Medium Enterprises (PASME) in 2015.
In 2014, the UAE established Federal Law No. 2 of 2014 to categorize SMEs, establish a dedicated council and determine incentives to be offered to small business owners. In Abu Dhabi, the Khalifa Fund for Enterprise Development launched in 2007 with AED2 billion in capital to create a new generation of Emirati entrepreneurs. It supports and develops small and medium-sized businesses in the Emirate. Meanwhile, Dubai has the Mohammed bin Rashid Establishment for Small and Medium Enterprises Development, also known as Dubai SME. The organization enables startups and high-potential SMEs through a range of support services such as development advisory, capability building, licensing, funding and business incubation. While these efforts have laid the groundwork for a SME growth policy, more needs to be done. Facilitative regulatory mechanisms can include setting up SMEs funds for subsidized financing and effective mentoring, changing company laws to allow more flexibility in structuring companies and allowing greater foreign national ownership, making intellectual property protection and commercialization easier, and integrating SMEs into critical supply chains through inclusive procurement policy.
For instance, the UAE Federal Law No. 2 stipulates that government authorities and ministries must procure at least 10% of their goods, services and consultation from SMEs. Human capital needs to stay very much in focus. SMEs will need access to suitably trained national talent. Yet public schooling systems in GCC countries often have trouble producing candidates of the requisite level due to old curricula, rigid pedagogy and language barriers. Innovation requires a pipeline of talent, which in turn necessitates education sector reforms across two fronts. First, the public schooling system needs to be made more effective in producing the right talent with the skills needed to adapt to the present and future. Second, the private schooling system should be supported by fair regulations that keep the ecosystem accessible for parents wanting quality education for their children without spiralling costs.
The road ahead
SMEs currently play a very important role in GCC economies. They will also power future prosperity by leading the charge in terms of innovation and helping to provide gainful employment to nationals who can no longer look to the public sector for jobs. Yet to evolve the requisite size and maturity, the SMEs ecosystem needs broad-based collaborative action to overcome key hurdles and build the necessary human capital, R&D capacities and institutional capability needed.
Political will, imaginative solutions and a shift in mindset are all required to effect meaningful change across they key areas of education, private sector activity, government, public companies and technology transfer. Educators need to be empowered to create the right talent, while the private sector should be incentivized to invest in research. Governments can accelerate educational investments and focus on establishing scientific institutions and supporting infrastructure. Meanwhile, public-private partnerships can facilitate technology transfer and scale up local value chains.
Bloovo.com's research is meant as an analysis of the status quo on the way to setting a blueprint for future goals. It wants to support GCC governments in catalyzing growth in their SMEs sectors. It might point out systematic challenges, but also offers comprehensive recommendations for overcoming these hurdles. The aim is to deliver a roadmap for decision-makers to develop a sophisticated SME ecosystem, driven by knowledge, technology and innovation.
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