Internationalisation of Small Medium Sized Enterprises in Indonesia: Entrepreneur Human and Social Capital

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1 Internationalisation of Small Medium Sized Enterprises in Indonesia: Entrepreneur Human and Social Capital Diana Sari Quamrul Alam Nicholas Beaumont Dept. of Management Monash University Abstract Small and Medium Enterprises (SMEs) have played an important role both in developed and developing economies. The research on internationalisation has mainly focused on large companies, especially Multinational Companies (MNCs) and only limited studies have been conducted in internationalisation of SMEs in developing countries. In recent years, the Indonesian government has acknowledged SMEs as a key source of domestic income growth and employment creation. While SMEs have been recognised as a source of domestic income through export activity, Indonesian SMEs only play a small role compared to Large Enterprises (LEs). Indonesian SME exporters represent only 21% of non-oil and gas exports. Policies and programs to assist SMEs to internationalise must be guided by clear understanding of the dynamic nature of SMEs. This paper proposes factors that may influence Indonesian SMEs to internationalise, namely, entrepreneur human and social capital. The study will use qualitative as well as quantitative data analysis. The sample will be drawn from owner-manager manufacturing SMEs (independent, with fewer than 100 employees, and managed by owners) from selected provinces in Indonesia based on a governmental database. It will cover industries such as the garment, furniture, handicraft, leather products and footwear industries. NVivo will be used to analyse the qualitative data while statistical software will be utilised to analyse the quantitative data. This paper argues that financial assistance will be useless for SMEs without an entrepreneurial spirit. Keywords: SME internationalisation, developing countries, exporting SMEs Introduction Small and Medium Enterprises (SMEs) have played an important role in developed and developing economies: SMEs account for more than 95% of all firms in many countries (Yu-Ching, Kuo-Pin, & Yu, 2006 p.495). In Indonesia SMEs have historically become a concern for government since the New Order era ( ), as is reflected in key government documents, such as the Five-Year Development This paper was presented to the 17 th Biennial Conference of the Asian Studies Association of Australia in Melbourne 1-3 July It has been peer reviewed via a double blind referee process and appears on the Conference Proceedings Website by the permission of the author who retains copyright. This paper may be downloaded for fair use under the Copyright Act (1954), its later amendments and other relevant legislation.

2 Page 2 Plan (Repelita), the Board Outlines of Government Policy (GBHN) and others (Hill, 2001). Successive Indonesian governments have never enunciated a coherent, clearly defined, and prioritized SME policy and strategy. There are a plethora of programs designed to assist SMEs, but these programs have achieved limited success (Hill, 2001 p.250). Examples are the financial support program known as the KMKP (credit for working capital), which was introduced in 1973 and continued in the 1980s, and the Bapak Angkat (foster-father) program that linked LEs and SMEs through subcontracting programs, but these did not achieve significant results (Hayashi, 2005). Wie (1994) recognized that these unsuccessful outcomes arose from inadequate institutional capability in the government sector as well as from inadequate design of policies and programs. The role of SMEs in Indonesia s economy is very significant. According to the Indonesian Central Bureau of Statistics (2006), there are 48.9 million SMEs in Indonesia and they account for 99.9% of total business. SMEs in Indonesia employ 85.4 million people, which is equal to 96.18% of the total Indonesian workforce. Moreover, the contribution of SMEs to gross domestic product (GDP), excluding oil and gas, is 53.3%. The three sectors that employ most of the workforce are agriculture, with 38.8 million workers (43.66%), trading and hotels, with 22.2 million workers (24.98%), and services, with 9.4 million workers (10.5%) (Ministry of Public Welfare, 2007). Indonesia experienced a 13% decline in its GDP in 1998 and a large devaluation of its currency, which soared from 2,500 rupiah to the US dollar to above 10,000 rupiah in the years after the crisis (Wengel & Rodriguez, 2006). LEs and SMEs responded differently to the Asian crisis. LEs contracted and reduced their exports; SMEs grew and expanded their exports, although many of them have also been hit hard (Berry, Rodriguez, & Sandee, 2002). In times of crisis, Indonesian SMEs have shown their ability to survive. The crisis brought an unexpected windfall for SMEs. With a depressed local market and a higher local price for their products, SMEs had to find new markets and many switched to international markets (Wengel & Rodriguez, 2006). During the crisis Indonesian SMEs exported their products to other countries in order to gain more profit. Most SMEs in Indonesia are not directly involved in global markets; only a

3 Page 3 small percentage export directly while others export through intermediaries; their contribution has therefore not been at the maximum, compared to LEs. The recent successes of SMEs in international markets have compelled many developing countries to pay attention to finding suitable policies and programs aimed at the development and export capabilities of SMEs. To be able to provide effective policies and programmes, policy-makers must have a good understanding of the dynamics of SMEs and the factors that influence their decision to enter the international market (Obben & Magagula, 2003). This paper focuses on exports because they represent the hallmark of productivity, and also because potential SME exports may contribute significantly to total export growth. Further, export performance could allow for formulation of clear policy measures to help reduce the gap between the actual and the potential capacity of small firms (Wengel & Rodriguez, 2006). At the micro-level, Chen and Tang (1987), in a study that compared technical efficiency in Taiwanese firms, conclude that exportoriented firms are more competitive and efficient than import substitution-oriented firms. Drawing on the important observations of Wengel and Rodriguez (2006), this paper aims to suggest a conceptual framework for the internationalisation process of SMEs in Indonesia and assess its impact on their performance. With reference to theory and empirical research, a conceptual framework is proposed. The last section discusses implications for policy makers, SME owner-managers and researchers. Definition of SMEs There is a variety of definitions for SMEs, according to country of origin. The definition is an important tool for implementing efficient measures and programmes to support the development and success of SMEs (European Commission, 2003). Some researchers define SMEs on qualitative and others on quantitative criteria (Von Potobsky, 1992); however, most definitions are based on quantitative criteria, as they are easier to evaluate and compare. Definition of SMEs also varies amongst different Indonesian government agencies: for example, according to the Ministry of Industry, a Small Enterprise is a business establishment with assets (excluding land and building) of less than 200 million

4 Page 4 rupiah; Medium Enterprises are from 200 million up to 5 billion rupiah; and firms of more than 5 billion rupiah are considered as LEs. A different definition is given by the Central Bureau of Statistics (Biro Pusat Statistik [BPS]), which classifies enterprises systematically according to the number of fulltime employees. From 0 to 4 workers a firm is classified as a Cottage or Household Enterprise (CHE), those with 5 to 19 workers as Small Enterprises (SEs), and those with more than 19 as Medium Large Enterprises (MLEs). According to the definition of the Ministry for Cooperative, Small and Medium Enterprises (2007), SMEs involve people activity on a small to medium scale, with criteria as follows: 1) they have maximum net assets of up to 10 billion rupiah, excluding land and buildings; 2) they are owned by Indonesians; 3) they comprise independent companies not owned by a large company and directly or indirectly affiliated with a large enterprise; and 4) they are individual companies, with or without legal entity status. In this study, the definition from the Ministry for Cooperative and SMEs will be taken into account. Theoretical and Conceptual Framework It is important to examine the literature on various variables or factors that affect a firm s internationalisation to identify the most important variables that drive SMEs to internationalise their operation. The following section will elaborate factors affecting firms decisions to internationalise. The Entrepreneur Perhaps some of the most studied variables in the internationalisation of SMEs are the manager s attributes and the relationship between the perception and attitudes of the manager and decision makers and the internationalisation of the firm. Wiedersheim- Paul, Olson and Welch (1978) developed a model that stresses the importance of a firm s activities and its pre-export behaviour. The important factors include information and characteristics of the decision maker, the enterprise environment, and extra-regional expansion of the firm. The entrepreneur is regarded as an important element in studying SME internationalisation and in the central factors that explain a firm s international behaviour (Andersson, 2000). Other empirical studies have shown that individual characteristics affect the processing of export-related information and

5 Page 5 influence exporting behaviour: see Reid (1981), Cavusgil and Naor (1987), Aaby and Slater (1989), and Ruzzier et al. (2007b). Human Capital The relative importance of the various dimensions of human capital embodied in the entrepreneur, as these relate to internationalisation of SMEs, has been extensively researched by Ruzzier et al. (2007). They identified four dimensions of human capital that had a positive relationship with internationalisation namely: International business skills ( international work experience, international business education and foreign languages) International orientation (days per year on business trips out of Indonesia, days per year on all trips out of Indonesia) Managerial competencies (motivating employees, negotiating team building and management and oral presentation), and Perception of environmental risk ( international business riskier than home, international business very risky). Besides the entrepreneur s human capital, it is suggested that social capital also affects a firm s internationalisation process (Chetty & Agndal, 2007). Social Capital Social capital is defined as the actual and potential resources embedded within, available through and derived from the network of relationships possessed by an individual or organisation (Nahapiet & Ghoshal, 1997). Adler and Kwon (2002, p.23) propose social capital as the goodwill available to individuals or groups. Its source lies in the structure and content of an actor s social relations. Its effects flow from the information, influence and solidarity it makes available to the actor. Adler and Kwon differentiate three dimensions of social structure that are rooted in different types of relations: market relations, in which products and services are bartered or exchanged for money; hierarchical relations, in which obedience to authority is exchanged for material and spiritual security; and social relations, in which favours and gifts are exchanged.

6 Page 6 While Adler and Kwon s division of social capital mainly considers the relationship of the actors, Nahapiet and Ghoshal (1997) consider three dimensions underlying social capital: The structural dimension, (connection with government officials, connections with top managers of other firms, connections with community leaders) The relational dimension (share same language and code with partner), and The cognitive dimension (trust). Managerial social capital is derived from networking relationships with top managers of other firms and government officials and is characterised by a high level of intimacy, reciprocal services, and emotional intensity (Granovetter, 1985). Recent study done in Ghana by Acquaah (2007) shows that social capital development from social networking relationships and ties with top manager of other firms, government officials and community leaders has a significant impact on organisational performance. In his study, Acquaah broadened the view about social relationships by including not only the connection to top managers of other firms (Peng & Luo, 2000), but also to government officials and community leaders. Peng and Luo find that the impact of social capital on organisational performance is higher for smaller firms and firms in low-growth industries. With regard to the Indonesian context the relationship with government officials still has an important role in business operations. Chetty and Agndal (2007) suggest that social capital should be developed and managed, because it could be used to enable mode changes, since the information acquired through social capital may enable a firm to switch mode more quickly. Further, Johanson and Mattsson (1985) suggest that a firm s success in entering new international markets is more dependent on its relationships within current markets, both domestic and international, than it is on the chosen market and its cultural characteristics. Conceptual Framework Indonesia, as an emerging economy, has been pursuing an incremental approach in its economy development policy, mainly focusing on import substitution. Indonesia follows a gradualist approach to internationalising its businesses. Export-oriented

7 Page 7 industrialisation policy has had an impact on the internationalisation process. The main mode of engagement of internationalisation in Indonesian SMEs has been indirect export using intermediaries; they have gradually moved to engagement in higher-involvement modes of entry, such as licensing and FDI. Macro and micro environment features are used to assess the extent to which Indonesian firms use social capital in business networks for their growth. The collective social interaction in Indonesian society is an important dimension of the social network within which businesses operate. These social networks play a significant role in public policy in implementing the internationalisation of business. Antoncic and Hisrich (2000) have developed a comprehensive model which tries to explain the multidimensionality of internationalisation. The model on which this paper is based was adopted originally from Antoncic and Hisrich s model, as modified by Ruzzier et al. (2006). The next part of the model pertains to internationalisation, which is assumed to comprise five dimensions: mode, market, time, product and international performance. Internationalisation in the model as the independent variables. The internationalisation construct has been empirically tested on Slovenian SMEs (Ruzzier et al., 2007a). While previous studies, as we have discussed, have examined the role of the entrepreneur, company and environment characteristics in the internationalisation process, few have measured and empirically tested all these factors simultaneously and none have been done in developing countries. This reinforces the need for empirical work to investigate antecedents of the internationalisation of SMEs in developing countries. The proposed conceptual framework will be used to collect data and construct an architecture showing the relationship between independent and dependent variables.

8 Page 8 Framework: Internationalisation of Small Medium Sized Enterprises in Indonesia: Entrepreneur Human and Social Capital Entrepreneur human capital International business skills International orientation Managerial competencies Risk Perception Entrepreneur social capital Internationalisation mode market time products international performance Structural Relational Cognitive Methodology The proposed study is basically an empirical study that will employ both qualitative and quantitative methods of analysis (mixed methods). Even though the focus will be on cross-section dynamics, as can be seen from the survey method employed, the time series progression of the development of manufacturing exporting SMEs will also be investigated. Sample Sample will be drawn from owner-managers of manufacturing SMEs (independent, with fewer than 100 employees, and managed by owners) from selected provinces in Indonesia, based on a government database. It will cover industries such as the garment, furniture, handicraft, leather products and footwear industries. A probabilistic (random) sampling method will be employed. A two-step process will be used. First, manufacturing exporting SMEs on the Ministry for Cooperative, Small Medium Enterprises and local government database will be selected randomly. Second, questionnaires will be mailed to a manager or decision maker in the company in a simple (or stratified) random sample of selected firms identified in step one.

9 Page 9 Data Collection The survey will be conducted through a mail survey. The Manager or Top Management in the company will be chosen as the key informants, since they are likely to be the most knowledgeable about the overall situation of the firm. Interviews with several selected SMEs (approximately 6 firms) will be carried out following the quantitative analysis in order to gain in-depth information regarding internationalisation and its effect on firm performance. Conclusion and Implications The above conceptual framework of internationalisation process of SMEs in Indonesia suggests that human and social capital may influence SMEs to internationalise. The framework offers some implications for policy makers, SME managers or owners and researchers. Many young and small SMEs need to address liabilities relating to newness, smallness and inexperience. Theoretical evidence shows there is a need for policy to focus on entrepreneurs (not only SMEs) with regard to the design of policies to support internationalisation (Westhead et al., 2001). Several aspects have to be taken into account, as most Indonesian government support has mainly focused on access to capital, and international promotion. However, to develop effective and efficient policies and programmes, policy-makers must have a good understanding of factors that influence the internationalisation of SMEs and then prioritize which area has to be concentrated on in the first place. Policy makers may target their supports for group of entrepreneur that offer greater internationalisation potential. Westhead et al (2003) point out that there are differences between inexperienced entrepreneurs and experienced habitual entrepreneurs. The latter may have experimental knowledge in domestic as well as international market. For example, entrepreneurs who own more than one business simultaneously (i.e., portfolio entrepreneurs) predominantly have more resources at their disposal and identify more opportunities (Westhead, 2005).

10 Page 10 SME managers or owners must be aware of the dynamic nature of internationalisation and it is important to discern the complexity of internationalisation and also regularly monitor the multiple elements that may influence internationalisation. The collective social interaction in Indonesian society is an important dimension of the social network within which businesses operate. As cross-sectional methods are difficult for capturing cause and effect, longitudinal datasets are needed to address this. In-depth case studies may offer valuable findings in this research area. For that reason, mixed methods can be used for the proposed conceptual framework. Finally, effort should be made to target the promising entrepreneur that offers international potential.

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