Institutional Arrangements and the Performance of Micro and Small-Scale Clothing Enterprises in Kenya

Transcription

1 Institutional Arrangements and the Performance of Micro and Small-Scale Clothing Enterprises in Kenya By Rosemary Atieno Institute for Development Studies University of Nairobi Draft paper submitted to the CSAE conference March 2009, St Catherine s College, Oxford University

2 Abstract Micro and Small Scale Enterprises (MSEs) play an important role in the Kenyan economy mainly through its contribution to the country s GDP and employment. The development of MSEs has been identified as one of the strategies for the country s industrialisation, employment generation and poverty reduction. Existing evidence on MSEs in the country show that clothing and textiles is one of the major MSE activities with potential for the country s industrialisation and poverty reduction. It is one of the major sources of employment, providing upto 26% of manufacturing employment and characterised by a high proportion of small scale activities. Like other MSE activities in the country however, clothing enterprises continue to face a number of constraints which limit the realisation of their potential as sources of growth and employment. This raises the issue of how to enhance their performance and the exploitation of the sector s potential in providing employment and incomes. While there have been a number of discussions on how to address these constraints, there is little evidence on the role of institutional arrangements like networks and linkages in enhancing the performance of MSEs in the country. This paper explores the issue of whether and how networks and linkages among the MSEs affect their performance. The paper uses primary data collected from a sample of small scale clothing enterprises and key informant interviews in two urban centers of Kenya. It analyses the nature of linkages between MSEs and other firms as well as networks among MSEs, and their effect on the performance of these enterprises. The results show that although limited, the small scale clothing enterprises have different forms of networks and linkages among themselves and with other firms. Some of these linkages have advantages, which are reflected in the firms performance. The paper concludes that there is need for deliberate policy measures to strengthen the institutional networks among SMEs, which enable them access resources as a way of overcoming some of their constraints, thereby enhancing their contribution to economic growth. 1

3 1. Introduction The development of Micro and Small Scale Enterprises (MSEs) has been identified in Kenya s government policy like the Sessional Paper Number 2 of 1997 on Industrial Transformation to the year 2020, and the Sessional Paper Number 2 of 2005 on the Development of MSEs for Employment and Wealth Creation as one of the strategies for the country s industrialisation, employment generation and poverty reduction (Republic of Kenya 1997, 2005). Despite this recognition at the policy level, the sector continues to face a number of constraints that mitigate its contribution. This paper applies the New Institutional Economics (NIE) approach - to explore the issue of whether and how linkages among the MSEs affect their performance and their contribution to the economy. Clothing and textile is one of the MSE activities with a potential for the country s industrialization, and it is a major MSE activity in urban Kenya (Ouma, 2002; McCormick et al. 2002). The Regional Programme on Enterprise Development (RPED) study on manufacturing firms in Kenya found that the textiles sector provides 26% of manufacturing employment and is characterised by a high proportion of small-sized activities (Aguilar and Bigsten 2002). The sector, like other MSE activities in the country, faces a number of development problems. The limited employment opportunities in many African countries have however meant that a large section of the population is engaged in MSE activities (Daniels 2004). The MSE sector has also become a major employer of the female labour force. The 1999 national survey of MSEs estimated that 55.7% of the MSEs in trade are female-owned, while women own 67% of the MSEs in leather and textiles (CBS, K-REP and ICEG ). Literature from studies based on the NIE shows that linkages provide an important avenue through which firms can overcome some of their constraints, like the access to financial services information, markets and other services. Discussions from the NIE approach show that linkages enable firms to overcome some of their constraints and to 1 Central Bureau of Statistics (CBS), Kenya Rural Enterprises Programme (KREP) and International Centre for Economic Growth (ICEG). 2

4 achieve goals that they would otherwise not be able to achieve on their own. Networks like associations cushion firms and enable them to access different forms of services. However, empirical evidence has shown that due to weak linkages with each other, the MSEs fail to reap the benefits of inter-firm linkages, some of which include access to support services like finance (Oketch et al. 2002). The question which emerges is therefore that of how the linkages can contribute to the development of small-scale clothing enterprises. This paper explores the issue of whether and how linkages between MSEs affect the performance of small-scale clothing enterprises. This paper uses primary data collected from a sample of small-scale clothing enterprises in two urban centres of Kenya, Eldoret and Kisumu. These towns have past histories of textile industries, which have direct linkages with the clothing enterprises. The collapsed Kisumu Cotton Mills (KICOMI) was located in Kisumu, while Eldoret hosted the Rift Valley Textiles (RIVATEX) and Ken Knit among others. The two towns have also attracted MSE activities in the recent past due to the general collapse of manufacturing firms in the regions (Oketch et al. 2002). The data was collected through a survey of the sampled clothing enterprises and key informant interviews in the two towns. A total of 322 micro and small-scale clothing enterprises were interviewed through a structured questionnaire, with 162 enterprises in Kisumu and 160 in Eldoret. The rest of the paper is organised as follows: after this introduction and the presentation of Kenya s economic performance, employment and the MSE development in section 2 discusses the relationship between growth, employment and MSEs in Kenya. Section 3 presents the conceptual relationship between linkages, growth and employment generation. Section 4 discusses enterprise characteristics, mainly the linkages. Section 5 presents the relationship between the linkages and the enterprise performance. Section 6 ends with the summary and policy conclusions. 3

5 2. Economic Growth, Employment and the Development of the MSE sector in Kenya In Kenya, the problems of persistent and increasing poverty and unemployment have been major challenges facing the country since gaining political independence, and a number of initiatives have been undertaken to address them. Most of these initiatives have emphasised achieving rapid economic growth as a means to reducing poverty and improving the standard of living. This approach succeeded for a while as the country recorded high rates of economic growth during the first decade of independence. The economy grew by 6.6% per annum during the period This was however not sustained. Since the late 1970s, the country has experienced a steady decline in economic performance culminating in the negative growth rate of -0.2% that was recorded in 2000 (Republic of Kenya 2001). Although there has been positive growth, it has not reached the targeted level as stated in the Economic Recovery Strategy for Wealth and Employment Creation (ERSWEC). Poverty and unemployment still remain major challenges to the country s development. The declining economic performance meant a declining ability of the economy, particularly of the formal sector to generate additional employment opportunities, leading to worsening standards of living within the population. Poverty and unemployment have continued to increase, becoming more entrenched over time and increasing more rapidly in the 1990s. Evidence from various estimates of poverty in the country over time show that poverty levels increased steadily from 29% in 1980, to 40% in 1994, and reaching 52% in 1997 (UNDP 2002). By 2003 the poverty level was estimated at 56%, with poverty being highest in the rural areas where the poverty level stands at 59.56%, compared to 51.48% for the urban areas (Mwabu et. al. 2001; Republic of Kenya 2005). At the same time, public sector employment declined from the mid-1980s, mainly due to the economic reforms like retrenchment programmes, privatisation of public enterprises, and shedding off of labour in private companies undergoing restructuring. The formal sector employment was particularly hit by the decline in economic performance. While the formal sector wage employment grew by 2.1% in 1998, this rate 4

6 declined to 0.6% in 1999, to 0.4% in 2000, and recorded a negative growth rate of -1.1% in 2001 (Republic of Kenya 2002). As the formal sector has declined, the informal sector has become increasingly important in the Kenyan economy as a source of employment and incomes. The share of employment between the formal and the informal sectors has changed drastically since then, with the latter overtaking the former in employment absorption. During the last decade, the growth rate in the informal sector s employment has remained above that of the formal sector. This has seen the sector s share in total employment rise from 16% in 1980, to 63.6% in 1997 and to 70% in Currently, the informal sector s share in total employment stands at 75% (Republic of Kenya 2005). Between 2000 and 2001, employment in the informal sector rose by 11.4% (see figures 1 and 2). Sector-wise, the informal sector is the second largest source of employment after small-scale agriculture (Ministry of Finance and Planning, 2000). The 1999 National Survey of Small and Micro-enterprises (SMEs) found that about 26% of the total households in the country are engaged in some form of SME activity (CBS KREP and ICEG, 1999). 5

7 100.00% 90.00% Fig. 1: Percentage shares of Formal and Informal sector employment ( ) Percentage shares 80.00% 70.00% 60.00% 50.00% 40.00% 30.00% 20.00% 10.00% 0.00% I.S Employment as a% of T.E F.S Employment as a % of T.E Years Source: Computed from economic survey, various issues Fig. 2: Formal and Informal Employment Trends ( ) ' Emplyment levels Informal Employment Total Employment Total F.S Years Source: Computed from Economic Surveys, various issues 6

8 The informal sector, within which most of the MSEs fall, is therefore an important component of the Kenyan economy towards employment generation. Most MSEs are informal in nature. The MSE sector has grown fast, from 910,000 enterprises in 1993 to 1.3 million enterprises in The 1999 national survey of the MSEs shows that while 48% of the enterprises are owned by women, and 52% by men, most enterprises (64%) are in trade and 66% are found in rural areas. These characteristics are important for poverty reduction since poverty is highest in rural areas while women are most affected by poverty compared to men. The MSEs are therefore important in the economy for wealth and employment creation through increasing incomes and the high contribution to GDP (ACEG 2005). 3. Linkages and the MSEs: Potentials for Growth and Income Generation 3.1 Institutions, Linkages and Enterprise Development Institutions have been defined as a set of constraints governing the behavioural relations among individuals and groups. Nabli and Nuggent (1989) observe that institutions have the ability to govern the relations among individuals and groups. They are predictable, understood as either formal or informal ones, like labour unions, markets, contracts, as well as cultural rules and codes of conduct as different forms of institutions (Nabli and Nuggent 1989). The importance of institutions derives from the fact that economic actions take place in a social context. According to Grannovetter (1985), economic actions are embedded in social contexts. Hence an entrepreneur, being a socially embedded individual, will use his personal networks for the benefit of the enterprise. The position of the person in the network and the power associated with the position determines the benefits of such networks to the enterprise. Networks of relationships shape the form that market exchange takes. Due to the externalities generated by networks, market entry is easier for members of a specific network than for others (Fafchamps 1999). Linkages can be seen either as part of a wider network of social relationships, or narrowly as connections between persons and organisations (McCormick and Atieno 2002). 7

9 Linkages can be classified into contracts, collaborations, contacts, and associations. This study draws from the different perspectives arising from the discussions on linkages, and focuses on linkages among firms, rather than linkages as part of a wider network of social relations. The focus is mainly on economic relationships, but the non-economic aspects of the interactions are also considered in the context of how they affect the firms activities. Both theoretical and empirical evidence suggests that specific social relations are among the factors that affect economic activities (Grannovetter 1985; Whitley 1992). Networks of interrelations can enhance the performance of manufacturing enterprises, but can also help to reduce the uncertainties faced by enterprises. Networks can affect enterprise performance by providing entrepreneurs with information on various aspects like markets and technology. Information about output markets, their functions and standards, may help enterprises become more competitive, with direct effect on productivity (Barr 1998). In most African countries, uncertainties are caused by poor contract discipline and also by poverty. A network that reduces uncertainty may increase performance indirectly by encouraging higher levels of investments. Barr (1998) concludes that networks affect enterprise performance in different ways and extents, depending on the functions they are built to perform. This is because alternative network structures suit alternative functions. Entrepreneurs with larger enterprises tend to maintain large, diverse and less cohesive innovation networks, which are more suited to providing information about technology and markets. On the other hand, entrepreneurs with smaller enterprises tend to maintain small homogeneous and cohesive networks suited to reducing information asymmetries and hence supporting informal credit and risk sharing arrangements. The paper further concludes that the smaller solidarity networks may have a marginal effect on enterprise productivity, while it is the innovation networks that have a large and significant impact. There are a number of reasons for joining associations. The building of social capital is one reason for joining associations. It enables people to make contacts that they hope to help them in future. In considering the role of associations, their size has been found to be important in determining their benefits. Barr (1998) notes that smaller businesses tend to 8

10 adhere to smaller networks while larger businesses tend to choose large networks. The small networks, typical of small scale enterprises, are often motivated by the desire to reduce risks while those by large businesses aim at enhancing business performance. While small networks may have marginal effects on enterprise productivity, it is the innovation networks that may have larger and significant impacts. The nature and relative importance of private and spillover effects also vary between small and large networks. Small networks tend to generate significant positive spillovers since within themselves it is difficult to exclude individuals from the benefits of the networks. Large networks to which large enterprises belong tend to generate high private returns (Barr 1998). McCormick et. al, (2003) note that to survive in business MSEs need - in addition to their entrepreneurial skills - some lobbying activity for a friendly business environment. In most cases, MSEs find the tackling of such problems on an individual basis rather difficult, due to a variety of reasons. Belonging to associations therefore becomes helpful. But although benefits to associations may seem obvious, research has shown that only a minority of the MSEs belong to any type of business support group (CBS et al 1999). The fact that MSEs seem to limit their involvement in associations suggests that the associations may not meet their needs. Research on business systems (Oketch et al. 2002) shows that firms which are limited in resources, like small firms, may be constrained from joining any networks or having contacts due to the costs involved in such associations. This limits the extent to which they can influence the support mechanisms, like policies, legislations and infrastructure that affect their businesses. Small firms therefore face a number of constraints which are institutional in nature, but their weak organisational ability and the limited or nonexistent linkages limit the extent to which they can address such constraints. 3.2 Why Firms form Linkages Firms link in order to attain ends that they cannot meet alone. Linking enables firms to overcome some of their constraints like the lack of finance, of access to raw materials, of market information, and of inputs or technology. Hence one of the reasons why firms 9

11 form linkages and relations is for the purposes of acquiring finance and other services. Small firms are mostly constrained by lack of working and investment capital. Linkage between firms can ease such constraints by reducing the amount of fixed capital required. Vertical linkages between producers and their suppliers may bring credit that reduces the working capital requirements. Linkages may also provide access to new sources of capital, like being members of group lending schemes. In such schemes micro enterprises join together to guarantee each other loans. Small firms may also link with large firms as a way of being able to access superior management capability, technology, market information, and finance that are important for firm survival (Meyanathan and Munter 1994). This study considers linkages as relations between individuals or organisations, with firms being the main actors and hence the units of analysis. Linkages have a number of potential benefits to firms. They help to improve firm performance by reducing marketing costs, increasing firm flexibility, improving skills and their diffusion, as well as facilitating information-sharing (McCormick and Atieno 2002). As a form of network they also help reduce uncertainties faced by enterprises. Despite these potential benefits, existing evidence shows that most MSEs do not belong to any type of business support and have fewer interactions with firms that are bigger than they are in comparison to large firms. Their participation in associations is also limited. Studies have shown that they do not belong to associations that have benefits to their members (CBS et al, Oketch et al, 2002). Limited linkages among the MSEs limit their flexibility in taking up emerging entrepreneurial opportunities. This also contributes to inadequate technological transfer, poor information flow, weak subcontracting arrangements, and inadequate marketing opportunities as factors that can promote expansion. The main line of discussion with respect to linkages pursued in this paper is thus identifying the type of linkages existing between clothing enterprises and the benefits associated with the different types of linkages among the enterprises. In this paper we consider the different types of linkages, namely informal groupings, associations, subcontracting, and linkages between MSEs and financial institutions. 10

12 Literature on Business Systems and the NIE clearly document the advantages of linkages between firms (McCormick and Atieno 2002). They help firms to achieve goals that they would otherwise not be able to achieve on their own, like access to inputs, market information, and specialised services like finance. Linkages with other sectors enable MSEs to generate employment indirectly through other sectors. In the markets of second hand clothes, Parker and Torres (1994) observe that wholesale markets are more likely to employ more people than retailers. With the demand for second hand clothing rising in Subsaharan Africa, the market for second hand clothing is likely to remain active. However, although small-scale traders have linkages with specialised activities, they do not have any with financial institutions. 4. Firm Linkages and Institutional Arrangements among Clothing Enterprises This section presents the main empirical results. We start by giving a brief description of the main characteristics of the clothing enterprises. Different forms of linkages between firms are expected to bring different types of advantages to the enterprises. The existing linkages that exist among the clothing enterprises themselves as well as those between the enterprises and the financial institutions are identified and discussed. 4.1 Enterprise Characteristics In this section, we present the main enterprise characteristics like firm history, ownership, size, activities, and sources of finance. These characteristics are important in determining the development of firm linkages and their contribution to enterprise development. The nature of linkages and their benefits by firms for example is likely to differ by firm size 2. Studies have shown that large firms are more likely to receive more loans, have higher indebtedness, rely less on informal loans, and have more access to credit compared to the small firms, the majority of which get their loans from informal sources of finance (Bigsten et al. 2001). Large firms are also more likely to have large networks providing information about markets and technology (Barr 1998). The nature of firm ownership has 2 The definition of firm size used in this study is based on the GEMINI definition which considers firms with 1-10 employees as small, those with as medium, and those with over 50 as large. See also McCormick and Atieno (2002). 11

13 also been found to be important in accessing financial services (Ikiara et al, 2002; Oketch et al, 2002). Many MSEs are owned by Kenyans of African origin, but the share of African owned enterprises falls sharply when moving up the enterprise size scale as many Asians own medium and large scale firms. More established firms are also more likely to have stronger networks than the newly established ones. Most enterprises were started by single individuals, with the highest number of owners being three. The mean age for the enterprises was found to be 8.9 years. The data further shows that 71.7% of the enterprises in the sample were not more than 11 years old, implying that they were started after This is important, conforming to the observation that the informal sector in Kenya experienced its most rapid growth in the 1990s. This is the period when the Kenyan economy also experienced significant declines in its performance, with a major decline in the formal sector, resulting from - among other factors - the implementation of economic reforms. It is therefore possible to say that the growth of MSEs was a spontaneous development resulting from the formal sector s inability to generate employment opportunities for the increasing labour force. In terms of the gender of the enterpreneurs, 50.3% of those who started the enterprises were females, while 49.7% were males. The national survey of MSEs (CBS, KREP, ICEG 1999) showed that men own 52% of the enterprises, while women own 48% of the enterprises. The education level of those entrepreneurs who started the enterprises ranges from those with no education to those with university education. Most entrepreneurs however had a secondary level of education with training. They are concentrated between those having primary education with training and those having secondary education with training. This may imply that most people with this level of education fail to get employment in the formal sector, and thus resort to MSE activities. The sources of finance for enterprise start-up varied from own savings to retirement benefits and to gifts from relatives. The majority (56.8%) however started with capital from savings at home, while none of the enterprises started with a bank loan. It is also 12

14 noteworthy that only two enterprises started with a suppliers credit. Results from other studies have shown that small firms used less trade credit among Kenya s manufacturing firms, compared to large firms most of which obtained trade credit (Issakson and Wilhborg 2002). Bigsten et al, (2001) also find that large firms have more bank overdrafts compared to small firms in Kenya s manufacturing sector. The MSEs therefore appear not to have support services especially from the financial sector, and the small scale clothing enterprises are not any different. Enterprise ownership and size are important characteristics in determining its linkages and the access to services like finance as well as the performance. Enterprise ownership has been associated with the firms ability to mobilise financial resources (Ikiara et al, 2002). Bigsten et al. (2001) in their study of manufacturing firms in Africa observe that, although general financial market involvement in the form of borrowing is limited, there are differences across firm sizes, with large firms receiving more loans and having higher indebtedness than small firms. The results from this study show that women own 50.3% of all the enterprises in the study. This includes both single-owned enterprises as well as those with more than one owner. Since most enterprises are single owned, women therefore have ownership in upto half of the enterprises. This gender distribution of enterprise ownership compares with the results of the 1999 national survey of MSEs where 55.7% of the MSEs in trade are female owned, while women own 67% of the MSEs in leather and textiles (CBS, K-REP and ICEG 1999). The high proportion of enterprises owned by women is also important for poverty reduction. This is because women constitute a high proportion of the poor, and improving MSEs as a source of their incomes is one of the ways of addressing poverty. While there are different ways of measuring firm size, in this study firm size was considered in terms of the number of employees. Manufacturing firms in Africa have 13

15 been found to have different levels of productivity, depending on the size (Soderbom 2000). We find that over half of the firms had no employees. Most of the MSEs in clothing are single-owned. The activities of the clothing enterprises can be classified as either producers like tailors and repairers, traders (both wholesalers and retailers), or service providers. Different types of activities are not only likely to have different financial needs but are also likely to have different types of linkages. From the data we see that producers, consisting of tailors and repairers, constituted 55.6% of the enterprises, while traders were 44.4%, consisting of those selling second hand clothes (40.4%) and those selling new clothes (4%). Most enterprises were engaged in only one activity, with 91.3% of the sample enterprises having the main activity as contributing 100% of the total production. There is no diversity in activities among these enterprises. 4.2 Linkages among Clothing Enterprises Groupings and Interactions among the Enterprises The firms belonged to different forms of associations. Results from the study reveal that the clothing enterprises have different forms of interactions among themselves. Such interactions took the form of associations, of welfare groups among the entrepreneurs as well as of informal groupings. People join groups to make contacts that may not be of immediate benefits but which may become useful later, through either formal or informal networks (McCormick et al 2003). The main form of interaction that the MSEs belonged to were found to be business groupings or associations. A total of 73% of the enterprises had relationships with other enterprises either in the same line of business or in different lines of business, while 27% did not have any relationship. Most enterprises therefore interacted with each other. The reasons for those not having any relationship included lack of interest in groupings, the need for independence, not being established enough to join with others, fear of group mismanagement, and fear of associating with those they considered as competitors. 14

16 Subcontracting Subcontracting arrangements belong to a broader category of contractual linkages. The typical motives for subcontracting include the lowering of labour costs, reducing risks through lowering of fixed costs, the need to produce specialized products that would be difficult to produce in house, as well as keeping the business small. Enterprises can either receive or give out subcontracts. More than half of the enterprises did not receive any subcontracts, with only 45.3% of the enterprises receiving any subcontracts. Fear of inability to meet the subcontract targets, inadequate capacity to take subcontracts, inadequate finances to handle subcontracts, difficulty in getting subcontracts, being new in the business, and not being interested in subcontracts were the reasons given for not receiving any subcontracts. Among those which received subcontracts, most received them from firms of the same size in the same business (table 1). They received the least subcontracts from firms of the same size but in different lines of business. Table 1: Sources of Subcontracts by Enterprise Size Source of Subcontracts Frequency Percentage Same Size same business line Large firms same business line Large firms different business line Smaller firms different business line 13 4 Smaller firms same business line Same Size different business line No subcontract Total Source: computed from survey data 15

17 The kinds of subcontracts can be categorised into specialised subcontracts, seasonal subcontracts, and subcontracts arising from inadequate capacity. Most firms (18%) received specialized subcontracting, followed by seasonal subcontracting (15.5%), while subcontracts due to inadequate capacity were received by 11.8% of the enterprises. Most enterprises also did not give subcontracts, with only 47.5% of the enterprises giving out subcontracts. Having adequate capacity was the most common reason (24.2%) for not giving out subcontracts. Others included of not being interested, the need to be independent, and the fear of failure by the subcontracted firms to meet their obligations. For those which gave subcontracts, most of them gave to firms of the same size in the same line of business (table 2). Most enterprises (25.2%) gave out subcontracting due to inadequate capacity. The entrepreneurs in the clothing sector therefore seem to interact more with firms in the same line of activity and size. This may be a factor limiting the amount of resources that they can pool together if they are resource-constrained. It has been argued that the concentration of African entrepreneurs in the range of MSEs is due to their inability to mobilize financial resources that can enable them to move out of the MSE activities (Ikiara et.al, 2002). Table 2: Enterprises Given Subcontracts by Firm Size Firms receiving Subcontracts Frequency Percentage Large firms same business line Large firms different business line Same size same business line Same size different business line Smaller firms same business line Smaller firms different business line 0 0 Not giving out a subcontract Total Source: Computed from survey data 16

18 Associations Business associations have been defined as collective bodies that are intermediaries between individual business action and state action. They are therefore a kind of organisation that may influence the development of individual businesses. Associations perform facilitating roles for the development of networks among MSEs (Bennet 1998). Associations are established for various reasons which affect their effectiveness. While some focus specifically on the business activities of their members, others do not have business as their primary focus (McCormick et al 2003). Associations provide different types of benefits to their members. The results of this study however show that only 23.6% of the enterprises belonged to any association with enterprises in their line of activity, while 33.2% belonged to associations with enterprises not in the same line of business. Lack of interest in the associations was the main reason given for not belonging to any associations. Some entrepreneurs also feared mismanagement of the associations as they had experienced from other existing ones. Inability to meet the financial requirements by the associations also discouraged some enterprises from joining any. Associations among these enterprises were formed to serve various interests of enterprises and therefore existed for different purposes. These included the provision of credit to members, helping with welfare matters and business development. Some enterprises owners were found to belong to more than one association where one association did not serve all their needs. The multiplicity of membership to associations can be explained by why associations are formed. Associations are mostly formed among members with similar activities like women tailors, traders in a specific commodity, or even people from the same clan. Such criteria mean that one person can belong to more than one association to satisfy the different needs. 4.3 Linkages between MSEs and Financial Institutions In this section, we present results on linkages between clothing enterprises and financial institutions. One of the constraints often identified with MSEs is lack of finance. Over 17

19 half (58%) of the respondents indicated that they had no interaction with financial institutions for reasons including high transaction costs associated with services from such institutions, the repayment procedures, and the recovery methods employed by the institutions in case of default. There are different types of linkages between clothing enterprises and financial institutions. Linkages with Commercial Banks The main form of interaction between MSEs and commercial banks was found to be through savings by the enterprises. Most traders hold savings accounts with commercial banks. In most cases, they save the proceeds from their businesses with commercial banks. Group savings were also mostly saved with commercial banks. In addition to savings, borrowing is the other main service from financial institutions used by the enterprises. However, only 34.8% reported having ever directly applied for credit. In contrast to the low number that had borrowed any credit, the majority (78%) saved part of their earnings with financial institutions, with 55% saving with commercial banks while others saved with self-help groups, Micro-Finance Institutions (MFIs) and Rotating Savings and Credit Associations (ROSCAs). The challenge here is therefore on how to convert the savings to credit for the enterprises. Small-scale clothing enterprises mobilise savings through commercial banks, but such savings do not come back to them in the form of borrowing. Linkages with MFIs Microfinance refers to the practice of providing financial services, such as micro-credit, micro-savings or micro-insurance to poor people, by helping them to accumulate larger sums of money, thus expanding their choices and reducing the risks they face. Institutions providing these services are referred to as Micro-Finance Institutions (MFIs). Linkages with MFIs form the main means by which the MSEs access financial services. Their services to the MSEs were found to include the provision of savings and loans through groups, check clearance services, client training on business management, insurance services, as well as the provision of assets like heifers. MSEs interact with MFIs mainly through loans, provided mostly through groups. The groups form the main channel 18

20 through which loans are given to enterprises and are formed according to the specific requirements of respective MFIs. In most cases, groups accumulate their own savings before they can access loans from the MFIs. Such groups, through the savings they mobilise, act as security for the loans taken by the members. Some MSEs have relationships with more than one MFI, by belonging to different groups and using their membership to access loans from the different MFIs. The key informant discussions associated this with default problems among the members, and in some cases, with the collapse of businesses where entrepreneurs cannot meet their debt obligations. Enterprises which had interactions with financial institutions benefited in various ways. Accessing credit for their businesses is one major benefit of such interactions. Other benefits included business training, a secure and accessible savings facility, and cash transfer services. Some enterprises (61%) also belonged to groups that enabled them to access financial resources for their enterprises. Such groups include Rotating Savings and Credit Associations (ROSCAs), merry go-rounds, women groups, and welfare associations. Such groups provide not just financial services but also other services, like health insurance for members, training, and assistance in welfare matters which might affect their business, like cases of deaths. These services indirectly benefit the business by enabling entrepreneurs not to divert resources from the business. 5. Firm Linkages and Enterprise Performance One of the main reasons why firms link up is to ultimately improve their performance. Firm performance can be measured using different indicators, like profitability, growth in employment, production level, or even sales. In addition, firms also have their own indicators of measuring their performance (Meyanathan and Munter 1994; McCormick and Atieno 2002; Oketch et al, 2002). All these indicators however have their advantages and disadvantages. Profitability, for example, has the problem that most of the small firms do not keep records, and do not easily share income information. On the other hand, some firms may not grow, but may diversify into other activities as a strategy to avoid risk. In this study, we use firm performance based on specific indicators, which 19

21 incorporate both the enterprises own measures of performance as well as the conventional measures of performance. Following from the literature it is hypothesised that the different forms of linkages have a positive effect on firm performance. Firms involved in more linkages would therefore be expected to experience a better performance than those not involved in any linkages. The key informant interviews showed that entrepreneurs measured their performance in terms of employment - for both temporary and permanent employees, sales volume, and the number of branches that have developed out of the initial establishments. Firms also measure their performance in terms of the stock of materials that are held, the regional coverage of markets, and the level of specialisation on specific products. In this section, we look at changes in specific performance indicators since the enterprise has started business. These include the employment level, the production volume, the diversification into branches, and the sales volume. 5.1 What has changed? The results show that while most firms can be said to have expanded in terms of their production and sales, they have not diversified by splitting into different business activities or branches since their establishment. Key informant interviews showed that most of those that have grown have mainly moved from general production to specialised products targeting specific customers. Looking at changes in the mean values between the start of the enterprise and their state at the time of the survey, we find that at start, the number of enterprises without temporary employees was 264 (82%), but this had dropped to 191 (59.3%) of enterprises not having temporary employees at the time of the interview. Temporary employment as used in this study refers to the fact that due to fluctuations in the demand for their products, enterprises employ workers on temporary terms for piecework for specific works, as a way of reducing their costs. Periods of peak demand for a particular product therefore lead to high levels of employment for the specific tasks. On the other hand, whereas 91.6% of the enterprises had no permanent employees at start, 86.6 % had no 20

22 permanent employees at the time of the interview. Enterprises also considered the number of branches they had as an indication of expansion and therefore their performance. Only 10% of the enterprises reported as having one branch at start in addition to the initial establishment, but 18% of the sample reported having between one and three branches at the time of the interview. The number of towns covered by the enterprises in their marketing was also found to have changed. The proportion of traders covering only one town had decreased from 98% at start to 88% currently. This implies that more enterprises in the sample were currently covering more towns than they did at the time of their establishment. We tested for the significance of the differences between selected indicators at start and the current period (table 3). Table 3: Comparison of Means for Performance Indicators at Start and Current Period Indicator Mean Values t-values Now At start Mean Difference Production volume (units per day) ( ) (85.302) *** Temporary employment (number of employees) 2.53 (23.458) (1.027) * Permanent employment (number of employees) 0.28 (.928) 0.15 (.577) *** Sales volume (Kshs) 9203 (20524) 3476 (8288) *** Profit level (Kshs) 2711 (6663) 1232 (2727) *** Number of branches 0.21 (.464) 0.1 (.304) *** Number of towns covered 1.26 (.786) 1.02 (.222) *** Note: Figures in parentheses are standard deviations *** Significant at 1%; * Significant at 10% The results from the comparison of the means show that except for temporary employment, there are significant differences in the values of the indicators between the start of the enterprises and the current period. This can be taken to imply that, on average, there have been positive changes in these indicators between the time the enterprises 21

23 were started and the time when the interviews were conducted. On average therefore, enterprises seem to have experienced positive change in most of their performance indicators. The important question however is whether these improvements can be related to the linkages that entrepreneurs have especially with financial institutions. In the next section, we explore this question Linkages and Firm Performance In this section, we analyse the performance of the enterprises in relation to the different kinds of linkages that the enterprises have, based on the hypothesis that linkages improve firm performance. We compare selected indicators for enterprises with different types of linkages, against those without. The results of differences in the indicators for those enterprises having relationships with other enterprises versus those without show that the differences in production volume between those firms which had relationships with other firms and those which did not are significant. The difference in all the indicators between the enterprises belonging to associations with firms in the same line of business and those not in such associations is significant (table 4). Firms interacting with financial institutions were found to have significantly higher profits, higher production volumes, and higher initial temporary employment than those without such interactions (table 5). However, when we look at these differences for producers and traders separately, we see that for producers, only current production volumes differ, while for traders, only temporary employment numbers differ. We further investigated the significance of differences in these indicators for enterprises saving with financial institutions and those that did not. The results (table 6) show that those enterprises that save have significantly higher production volumes and profit levels than those enterprises that did not save. Within the framework of associations where the entrepreneurs operate, savings act as a security for loans either from the associations or the MFIs. Key informant interviews also indicated that although the clothing enterprises do not borrow as a group from commercial banks, some do borrow individually where their businesses can act as security. 22

24 Table 4: Comparison of Selected Indicators for those belonging to Associations with Enterprises in the same Line of Business and those not Indicator In association (n=76) Mean Value Not in association (n=246) t-value Production volume now *** Production volume at start *** Temporary employment now ** Temporary employment at start *** Sales volume now *** Sales volume at start * Profit level now *** Profit level at start *** *** Significant at 1%; ** Significant at 5%; * Significant at 10% Table 5: Comparison of Selected Indicators for those interacting with Financial Institutions and those not Indicator With interactions (n=134) Mean Value Without interaction (n=188) t-value Production volume now ** Production volume at start Temporary employment now Temporary employment at start * Sales volume now Sales volume at start Profit level now * Profit level at start ** Significant at 5%; * significant at 10% 23

25 Table 6: Comparison of Selected Indicators for those Saving with Financial Institutions Mean Value Indicator Those Saving Those not Saving (n=251) (n=71) t-value Production volume now *** Production volume at start Temporary employment now Temporary employment at start Sales volume now 10, , Sales volume at start 3, , Profit level now 3, , *** Profit level at start 1, , *** Significant at 1%; ** Significant at 5%; * Significant at 10% The results may lead to the observation that while some linkages may contribute to better performance of the enterprises, some do not. It however appears that the nature of the linkages is important. Membership to associations and interaction with financial institutions in the form of savings are significant in enterprise performance. Associations had different objectives, like the mobilisation of financial resources and the provision of credit to members as well as addressing social welfare issues that affect members business. This indirectly ensures that financial resources are not diverted from the enterprises, which might affect its performance. Interactions with firms in the same line of business also appear to be more important than those with enterprises in different lines of business. Interaction with financial institutions implies access to external sources of finance, which increases firm flexibility in resource allocation and the ability to take up emerging investment opportunities as well as to reduce cash flow problems. Key informant interviews showed that entrepreneurs formed groups either to directly facilitate access to credit for their business or to address non-business problems that affect their businesses. Most MFIs provide credit to enterprises only through associations or groupings. Such linkages are likely to improve financial flexibility of the enterprises. 24

26 6. Summary and Conclusions This paper investigated the nature of linkages among MSEs as well as with financial institutions, and the effect of such linkages on enterprise performance using primary data collected in two urban centres of Kenya. The results show that although limited, the small-scale clothing enterprises have different forms of linkages both among themselves, and with other institutions like financial institutions. Such linkages include associations which help to mobilise and allocate financial resources among their members, informal groupings, and savings with financial institutions. Linka ges with financial institutions mainly took the form of loans with MFIs while the interaction with commercial banks was limited to savings services only. Despite the limited linkages, the results show that where they exist, linkages have advantages to the enterprises, which reflect in their performance. Evidence from other studies have also shown that firms belonging to associations have better performance than those which do not belong to any association. This is because associations enable their members to access certain services which help them to improve their performance, like information, finance, and support on social issues that may affect their business performance. Associations were the main form of linkages with high level of overlap between social and business functions. Consolidating small associations may help to strengthen their bargaining power in terms of leveraging benefits for their members. This needs to be institutionalized into laws and regulations requiring smaller associations to have umbrella associations. Aspects of associations, which have been found to determine their success, are size, benefits offered and their operational rules among others (Bennet 1998). Finance is often one of the major constraints facing MSEs. Results from this study show that access to financial services through linkages is important for the clothing enterprises. The capacity for the different types of financial institutions - through which MSEs get 25