Chapter two small business

CHAPTER TWO
SMALL BUSINESS: VITAL COMPONENTS OF THE ECONOMY
2.1 definitions of micro and small enterprise/small business
The terms Micro-enterprise and small-enterprise refer in the first place to the size of
the business. For a long time, the concept of ‘informality’ has also used to characterize
micro and small enterprise, informality here refers to the informal nature of the
employment process (no contract of employment and low wages) and to the fact that most
of such business are not registered. However for a meaningful classification of firms into
categories, the size of firm or the degree of informality does not provide usable
yardsticks. A number of other characteristics of enterprises and of the entrepreneurs
who set up and run them must also be taken into account. At present in most countries, a
combination of the number of workers and invested capital are used as a yardstick.
World wide, individual countries apply their own definitions and criteria in defining
categories of small-scale enterprise. For instance definition applied to micro-enterprise in
Ethiopia is different from the developed countries such as the USA and UK – Attempt is
therefore made in this section to cite some of the definitions given to such categories of
enterprise by different countries including Ethiopia.
Micro and Small business enterprise is a specific form of small enterprise. It almost
involves businesses with informal characteristics. Such enterprises usually include small
service businesses, bakeries, metal working business, small furniture maker’s repair and
maintenance business, copying business, small scale food production business, etc… The
lower limit in the microenterprise category is the one-person business. The upper limit is
often fairly arbitrarily, drawn at business with a maximum of 10 employees and/or
maximum capital of about US Dollar 50,000. This definition usually refers to the category
set by most developed countries. Moreover, studies indicate that this group (micro-
enterprise) provides most jobs in the industrial sector of many developing countries
varying from 40% to 90%.
Generally, there are two approaches to define a small business enterprise. These are:
A. Size criteria and
B. Economic/control criteria
A. Size Criteria
Though the criteria used to measure the size of business may vary, the following criteria
are commonly used to measure the size of businesses.
i. Sales volume
ii. Number of employees
iii. Insurance in force

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iv. Volume of deposits

B. Economic/Control Criteria
The definition of a small business referring to economic/control criteria cover the
following:
i. Market share
ii. Independence and
iii. Personalized management
All of these three characteristics should be satisfied in order for the business firm to be
categorized as a small business. These characteristics are briefly discussed here under.
i. Market share: - The market share of a small firm is not large enough to enable to
influence the prices of national goods sold to any significant extent.
ii. Independence: - The owner of a small business is independent in that he/she has
full control over the business.
iii. Personalized Management: - It is the owner who actively participates in all
aspects of the firms’ management and in all major decision making processes. Thus,
there is little or no devolution of delegation of authority.
When we refer to the Ethiopia context, a standard definition to both micro and small
enterprise has been set by the ministry of Trade and Industry study on ‘MSEs
development strategy’ which took place on August 1997.
Accordingly, micro enterprises in Ethiopia are defined as those firms with less than ten
workforces and with a paid up capital of not exceeding birr twenty thousand. While the
small enterprises are defined as those ventures with less than ten workforces and with
paid up capital of not exceeding birr fifty thousand. The study notes that, over 89 percent
of the informal sector operators are concentrated in manufacturing and trade of hotels
and restaurants activities and 85 percent of the small scale enterprise and engaged in
manufacturing food fabricated metal furniture and weaving apparels.
2.2 Economic, Social, and Political aspects of Small Business Enterprise.
Industrialization is of crucial importance to sustainable development. Only very few
countries with a small population and a great wealth of natural resources have succeeded in
achieving a high degree of prospects. The success of a number of newly industrialized
countries, especially in East Asia, has emphasized the importance of the relationship and
interaction between agriculture, industry and the service sector. Within each of these
sectors strategic changes are taken place, with employment in agriculture almost always
going into sharp decline while employment in services and the industrial sector grows.
Growth in the industrial sector is less rapid than in the service sector however. In any

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case the changes referred to highlight the increasing importance of development in the
micro and small enterprise sector.
Developing countries are devoting attention to the development of small scale enterprises
in a variety of ways. The following are the major vital roles that micro and small enterprise
can play in the socio-economic development of a nation.
i. Micro and small enterprises are considered to be greatest value in building up a
local production structure and in promoting economic growth.
ii. Micro and small enterprise are also considered as a means of creating employment
opportunity and achieving a fair distribution of national resource income, knowledge
and power.
iii. Small scale enterprises are also seen as a seedbed for the development of local
entrepreneurship.
iv. Small enterprises are also important in that can help to promote rural
industrialization.
v. Small scale enterprises are also termed or seen as forms enterprises in which more
appropriate technology is applied. They require less capital and more labor. They
have the capacity to generate a much higher degree of employment with less capital
as compared to the large-scale sector. Thus, they are less capital intensive and
more employment oriented.
vi. Small-scale enterprises are also important in that can serve as suppliers of parts
and accessories to bigger industries. This ancillary function involves specialization
in specific areas and results in greater profitability.
vii. Small-scale enterprises or industries can also play a prominent role in promoting the
export market.
When seen from the individual point of view, going into small business has certain
advantages. As a result, the desire for individuals to own and operate their own small
business firm is growing. The following are some of four benefits that individuals pursuing
a career in business ownership can gain according to Scarborough and Zimmerer (1993:10-
112)
(a) Opportunity to gain control over own destiny : Owning a business provides the
entrepreneur the independence and the opportunity to achieve what is personally
important.
(b) Opportunity to reach your full potential : Too often, people find their work boring
and unchallenging. The small business therefore, becomes instrument for self
expression and self-actualization. In your won business, all of your skills and
abilities will likely be challenged. The only barriers to success are those that your

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creativity and determination cannot overcome limits artificiality created by the

organization that employs you.
(c) Opportunity to rap unlimited profits : Although money is not the primary force
driving most enterprises their ability to keep the money their business earn,
certainly is a critical factor in their decisions to launch companies. Without
question, men and women who apply their knowledge to produce valuable goods and
services and to solve problems of the society often are rewarded bountifully.
(d) Opportunity to contribute to society and be recognized for your efforts : We no
longer can depend solely on our own skills to provide for all our needs.
Entrepreneurs provide the rest of us with goods and services we need. Small
business owners/managers enjoy the recognition from customers when they have
served faithfully over the years.
Being a part of the business system, and knowing that their work has a direct
bearing on how the economy function is another reward for small business owners.
On the other hand, as indicated by Hailay (2003:27) some authorities classify the
advantages of owning a small business into six, namely independence, financial
opportunities, community service, job security, family employment and challenge. These
benefits are however, more or less similar to those pointed out by Scarborough and
Zimmerer.
2.3 The Potential drawbacks of Small Business Ownership
Although owning a business has many benefits and provides many opportunities, anyone
planning to enter the world of entrepreneurship should be aware of its potential
drawbacks. If you aren’t 100 percent sure you want to own a business’ says one business
consultant “there are plenty of demands and this laps along the way to dissuade you’. The
point is that, without proper preparation, an individual may find the career path of
business ownership frustrating. The major potential drawback therefore include,
uncertainty of income, risk of losing your entire invested capital, long hours and hard work,
lower quality of life until the business gets established and complete responsibility.
i. Uncertainty of income: Opening and running a business provides no guarantee that
an entrepreneur will earn enough money to survive. In the early days of a business
the owner often has trouble meeting financial obligations and may to live on savings.
ii. Risk of losing your entire invested capital : The small business failure rate is
relatively high. According to some research findings 24 percent of new business fail
within two years and 51 percent shut down within four years, within six years 63
percent of new business will have folded. Many of those entrepreneurs who fail will
have lost their personal saving.

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iii. Long hours and hard work: New business owners sometime are amazed at the
tremendous investment of time and energy required to get business of the ground.
In the start-up phase in particular the entrepreneur does everything alone-from
manufacturing and selling to cleaning and raising money. Studies for instance show
that the majority of new business owners work more than 60 hours per week. In
many star-ups, six or seven day work weeks with no paid vacations may be the norm.
When the business closes the revenue stops and the customers go elsewhere.
iv. Lower quality of life until the business gets established : The long hours and
hard work needed to launch a company can take their role on the remainder of the
entrepreneurs’ life. Business owners find their roles as husbands and wives or
fathers and mothers take a back seat to their roles as a company founders.
v. Complete responsibility: It is great to be the boss, but many entrepreneurs find
that they must make decisions on issues about which they are not really
knowledgeable. The realization that the decisions they make are cause of success
or failure of the business has devastating effect on some people. Small business
owners realized quickly that they are the business.
2.4 Causes of small Business Failure Factors
Failure can be thrust upon an entrepreneur through external conditions or fabricated by
the entrepreneur through personal short comings.
External factors of failure
Every business is affected by externalities; economic business cycles, fluctuating interest
rates interrupted supplies, labor market trends, inflation.
Personal factors of failure
The following can be cited as personal factors attributable to small business failures:
Inexperience: lack of technical skills and or management acumen. Each of these short
comings can be lead to disaster, but they also can be overcome by individual willing to make
the commitment of time and energy to learn about business.
Arrogance: Many small business persons become consumed with their own brilliance,
convinced beyond reason (often without market research) that their bright ideas will
change the world-it has got to sell. Their arrogance will not allow them to advice from
others.
Mismanagement: in experience entrepreneurs simply make bad decisions in critical
situations. Several categories of mismanagement take critical for small business to avoid.
 Over investment in fixed asset in common: When starting or expanding a business,
it is tempting to buy facilities and equipment rather than lease or subcontract.

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 Poor inventory control: This threatens the success of nearly all retail enterprises.
Purchasing too much inventory undermines customer selection and sales. Buying the
wrong inventory, or buying at wrong time, evaporates cash.
 Poor financial control: Many entrepreneurs fail to realize that”income”does not
“cash flow.”
Lack of planning: research shows less than half of small business owners had formal plans
prior to going in to business. Many engaged in formal planning soon after starting their
businesses, but one third could not recall ever having a formal business plan. It is nearly
impossible to acquire capital, obtains loans or solidifies vendor contracts without document
sales forecasts, financial statements, market analysis and a clear statement the business
purpose. Plans are guide lines for action.
WHAT IS BASIC BUSINESS IDEA?
 It is logical to think of a goal for the unit in long run rather than to look for the
immediate tomorrow. This long-term thinking is called basic business idea.
 The basic business idea and the product through hierarchy can be represented as
follows
Basic business idea
Product line
Product range
Product

Figure: Hierarchical presentation of business idea

Businesspersons should think of long-term goal and the profit when they start a business.
The basic business idea, which is at the top of the hierarchy, is to meet the broadest
needs of the customers, and has the long life perhaps from 5-50 years. The basic business
idea facilitates choice of product under an over all plan. Thus, entrepreneur may think of
being in the entertainment firm, in automobiles, in medicines, in services, in industries, etc.
The product line is relatively narrow and has a shorter life. The product line consists of
different families of product. A unit with a basic business idea for example packaging can
metal packages, aluminum packages, paper or wood packages.
The product range includes different size of the product with in the product line in the
examples given above different size of glass bottles can be manufactured for varied
applications.
The product is one item of the product range having different specifications like size,
material used and weight, etc.

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The basic business idea, which facilitates a choice of the product at different stages of
the product, allows for diversification and expansion. But the basic idea is not always the
same. In a dynamic business scheme, one has to carefully watch is one of the basic idea
degenerating as regards.
A. Its ability to generate quick returns
B. Its ability to permit quick changes in the products
The general business atmosphere guides the choice of basic business idea. A basic
business idea results from the identification of business opportunities in the market.
To be successful in business, consistently watch the opportunities to spot where the
entrepreneur has to be sensitive to the market changes, watch demand and supply, study
consumer behavior, and grasp the business idea.
SOURCES OF NEW IDEAS
Some of the more frequently used sources of ideas for new entrepreneurs include
consumers, existing companies, distribution channels, the federal government, and
research and development.
1. Consumers: Potential entrepreneurs should pay close attention to the final focal
point of the idea for anew product or service the potential consumer. This attention
can take the form of informally monitoring potential ideas and needs or formally
arranging for consumers to have an opportunity to express their opinions. Care
needs to be taken to ensure that the idea or need represents a large enough
market to support a new venture.
2. Existing Companies: Potential entrepreneurs and intrapreneur should also establish
a formal method for monitoring and evaluating competitive products and services on
the market. Frequently, this analysis uncovers ways to improve on these offerings
that may result in a new product that has more market appeal.
3. Distribution Channels: Members of the distribution channels are also excellent
sources for new ideas because of their familiarly with the needs of the market. Not
only do channel members frequently have suggestions for completely new product,
but they can also help in marketing the entrepreneur’s newly developed products.
One entrepreneur found out salesclerks that the reason his history was not selling
was due to its color. By heeding the suggestion and making the appropriate color
changes, his company became the leading supplier of non brand hosiery in that
region.
4. Federal Government: The federal government can be a source of new product
ideas in two ways. First, the files of the Patent Office contain numerous new
product possibilities. Although the patents themselves may not be feasible new

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product introductions, they can frequently suggest other more marketable product
ideas. Several government agencies and publications are helpful in monitoring patent
applications. Second, new product ideas can come in response to government
regulations. For example, the Occupational Safety and Health Act (OSHA), aimed
at eliminating unsafe working conditions in industry, mandated that three people.
The kit has to contain specific items that varied according to the company and the
industry. The weather proofed first-aid kit needed for a construction company had
to be different from the one needed by a company manufacturing facial cream or a
company in retail trade. In response to OSHA, both established and newly formed
ventures marketed a wide variety of first-aid kits. One newly formed company, R &
H Safety Sales Company, was successful in developing and selling first-aid kits that
allowed companies to comply with the act.
5. Research and Development: The largest source of new ideas is the entrepreneur’s
own “research and development,” efforts that may endeavor connected with one’s
current employment or an informal lab in the basement or garage. A more formal
research and development department is often better equipped and enables the
entrepreneur to conceptualize and develop successful new product ideas.
METHOD OF GENERATING IDEAS
Even with a wide variety of sources available, coming up with an idea to serve as the basis
for a new venture can still be a difficult problem. The entrepreneur can use several
methods to help generate and test new ideas, including focus groups, brain storming, and
problem inventory analysis.
1.Focus Groups: Focus groups have been used for a variety of purposes since the
1950s. A moderator leads a group of people through an open, in-depth discussion rather
than simply asking questions to solicit participant response. For a new product area, the
moderator focuses the discussion of the group in either a directive or a nondirective
manner.
The group of 8 to 14 participants is stimulated by comments from other group
members in creatively conceptualizing and developing a new product idea to fulfill a
market need. One company interested in the women’s slipper market received its new
product concept for: a “warm and comfortable slipper that fits like an old shoe” from a
focus group of 12 women from various socioeconomic backgrounds. The concept was
developed into a new product that was a market success. The basis of the advertising
message was formed by comments of focus group members.
In addition to generating new ideas, the focus group is an excellent method for initially
screening ideas and concepts. Using one of several procedures available, the results can

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be analyzed more quantitatively, making the focus group a useful method for
generating new product ideas. Focus group is groups of individuals providing information
in a structured format.
2. Brainstorming: The first technique, brainstorming, is probably the most well-known and
widely used for both creative problem solving and idea generation. It is an unstructured
process for generating all possible ideas about a problem within a limited time frame
through the spontaneous contributions of participants. A good brainstorming session
starts with a problem statement that is neither too broad (which would diversify ideas too
greatly so that nothing specific would emerge) nor too narrow (which would tend to confine
responses). Once the problem statement is prepared, 6 to 12 individuals are selected to
participate to ensure the representation of a wide range of knowledge. To avoid inhibiting
responses, no group member should be a recognized expert in the field of the problem. All
ideas, no matter how illogical, must be recorded, with participants prohibited from
criticizing or evaluating during the brainstorming session. The brainstorming method for
generating new product ideas is based on the fact that people can be stimulated to
greater creativity by meeting with others and participating in organized group
experiences. Although most of the ideas generated from the group have no basis for
further development, often a good idea emerges. This has a greater frequency of
occurrence when the brainstorming effort focuses on a specific product or market area.
When using this method, the following four rules should be followed:
1. No criticism is allowed by anyone in the group-no negative comments.
2. Freewheeling is encouraged-the wilder the idea the better
3. Quality of ideas is desired-the greater the number of ideas, the greater the
likelihood of the emergence of useful ideas.
4. Combinations and improvements of ideas are encouraged; ideas of others can be
used to produce still another new idea.
The brainstorming session should be fun, with no one dominating or inhibiting the
discussion.
A large commercial bank successfully used brainstorming to develop a journal that
would provide quality information to its industrial clients. The brainstorming among
executives focused on the characteristics of the market, the information content, the
frequency of issue, and the promotional value of the journal for the bank.
Brainstorming is a group method for obtaining new ideas and solutions.
3. Problem Inventory Analysis: Problem inventory analysis uses individuals in a manner
that is analogous to focus groups to generate new product ideas. However, instead of
generating new ideas themselves, consumers are provided with a list of problems in a

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general product category. They are then asked to identify and discuss products in this
category that have the particular problem. This method is often effective since it is
easier to relate known products to suggested problems and arrive at a new product
idea than to generate an entirely new product idea by itself problem inventory analysis
can also be used to test a new product idea. Results from product inventory analysis
must be carefully evaluated as they may not actually reflect a new business
opportunity. Problem inventory analysis is a method for obtaining new ideas and
solutions by focusing on problems.
4. Reverse Brainstorming Reverse brainstorming is similar to brainstorming, except that
criticism is allowed. In fact, the technique is based on finding fault by asking the question,
“In how many ways can this idea fail?” Since the focus is on the negative, care must be
taken to maintain the group’s morale. Reverse brainstorming can be effectively used
before other creative techniques to stimulate innovative thinking. The process most often
involves the identification of everything wrong with an idea, followed by a discussion of
ways to overcome these problems; reverse brainstorming is a group method for obtaining
new ideas focusing on the negative.
5. Synectics :-Synectics is a creative process that forces individuals to solve problems
through one of four analogy mechanisms: personal, direct, symbolic, and fantasy. A group
works through a two-step process. The first step is to make the strange familiar. This
involves, through generalizations or models, consciously reversing the order of things and
putting the problem into a readily acceptable or familiar perspective, thereby eliminating
the strangeness. Once the strangeness is eliminated, participants engage in the second
step, making the familiar strange through personal, direct, or symbolic analogy, which
ideally results in a unique solution being developed.
6. Gordon Method:- The Gordon method, unlike many other creative problem-solving
techniques, begins with group members not knowing the exact nature of the problem. This
ensures that the solution is not clouded by preconceived ideas and behavioral patterns.
The entrepreneur starts by mentioning a general concept associated with the problem. The
group responds by expressing a number of ideas. Then a concept is developed followed by
related concepts, through guidance by the entrepreneur. The actual problem is then
revealed, enabling the group to make suggestions for implementation or refinement of the
final solution. Gordon method is a method for developing new ideas when the individuals are
unaware of the problem.
7. Free Association One of the simplest yet most effective methods that entrepreneurs
can use to generate new ideas is free association. This technique is helpful in developing an
entirely new slant to problem. First, a word or phrase related to the problem is written

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down then another and another, with each new word attempting to add something new to
the ongoing thought processes, thereby creating a chain of ideas ending with a new
product idea emerging. Free association is the method of developing a new idea through a
chain of word associations.
8. Forced Relationships Forced relationships, as the name implies, is the process of
forcing relationships among some product combinations. It is a technique that asks
questions about objects or ideas in an effort to develop a new idea. The new combination
and eventual concept is developed through a five step process:
1. Isolate the elements of the problem
2. Find the relationships between these elements
3. Record the relationships in an orderly form
4. Analyze the resulting relationships to find ideas or patterns
5. Develop new ideas from these patterns
A forced relationship is a method of developing a new idea by looking at product
combinations.
9. Collective Notebook Method In the collective notebook method, a small notebook that
easily fits in a pocket containing a statement of the problem, blank pages, and any
pertinent solutions, recording ideas at least once, but preferably three times, a day. At
the end of a month, a list of the best ideas is developed, along with any suggestions. This
technique can also be used with a group of individuals who record their ideas, giving their
notebooks to a central coordinator who summarizes all the material. The summary becomes
the topic of a final creative focus group discussion by the group participants. Collective
notebook method is developing a new idea by group members regularly recoding ideas.
10. Heuristics This method relies on the entrepreneur’s ability to discover through a
progression of thoughts, insights, and learning. The technique is probably used more than
imagined, because entrepreneurs frequently must settle for an estimated outcome of a
decision rather than certainty one specific heuristic approach is called the Heuristic
Ideation Technique (HIT). The technique involves locating all relevant concepts that could
be associated with a given product area and generating a set of all possible combinations
of ideas. Heuristics involves developing a new idea through a thought process progression.
11. Scientific Method The scientific method, widely used in various fields of inquiry,
consists of principles and processes, conduction observations and experiments, and
validating the hypothesis. The approach involves the entrepreneur defining the problem,
analyzing the problem, gathering and analyzing data, developing and testing potential
solutions, and choosing the best solution. Scientific method is developing a new idea
through inquiry and testing.

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12.Value Analysis The value analysis technique develops methods for maximizing value to
the entrepreneur and the new venture. To maximize value, the entrepreneur asks such
questions as, “Can this part be of lesser quality, since it isn’t a critical are for problems?”
In a value analysis procedure, regularly scheduled times are established to develop,
evaluate and refine ideas. Value analysis is developing new ideas by evaluating the worth of
aspects of ideas.
13. Attribute Listing This method is an idea-finding technique that requires the
entrepreneur to list the attributes of an item or problem and then look at each from a
variety of viewpoints. Through this process, originally unrelated objects can be brought
together to form a new combination and possible new uses that better satisfy a need.
Attribute listing is developing a new idea by looking at the positive and negative.
14. Big Dream Approach The big-dream approach to coming up with a new idea requires
that the entrepreneur dream about the problem and its solution, in other words, thinking
big. Every possibility should be recorded and investigated without regard to all the
negatives involved or the resources required. Ideas should be conceptualized without any
constraints until an idea is developed into a workable form. Big-dream approach is
developing a new idea by thinking about constraints.
15. Parameter Analysis A final method for developing a new idea-parameter analysis
involves two aspects: parameter identification and creative synthesis. Step one (parameter
identification) involves analyzing variable sin the situation to determine their relative
importance. These variables become the focus of the investigation, with other variables
being set aside. After the primary issues have been identified, the relationships between
parameters that describe the underlying issues are examined. Through an evaluation of
the parameters and relationships, a solution(s) is developed; this solution development is
called creative synthesis.
2.5 Steps in setting a small scale unit.
The following are the major steps in setting small scale unit:
1. Select the right product: the first key to success in any manufacturing activity is to
select the right product. In the beginning, information of possible lines of activity must be
obtained, by talking to knowledgeable people, from industrial publications, or from various
organizations.
2. Preparation of detailed project report: This will cover the following aspects:
a) A detailed estimate of demand is to be made-The total demand, existing suppliers and
the capacity of existing units, the demand gap to be met, the customers, the distribution
method required have all to be studied.

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b) Technical specifications of the process should be carefully studied-the know- how may
be available with the person himself or may be obtained from literature, or from others
including government laboratories like the national laboratories, etc.
c) The equipment required and the sources are to be specified.
d) Requirements of space-land, shed etc.and other utilities like power and water are to be
assessed.
e) Man power requirements of direct and indirect personnel are to be determined and
their availability ensured.
f) Cost of the project to be worked should be identified.
3. The action phase begins- The form of ownership is to be decided upon and the
company formed and registered. Following this, action directed towards obtaining finance,
necessary licenses and necessary infrastructure is to be taken. This would involve dealing
with various government bodies and other institutions like: financial institutions for
finance; sales tax, income tax authorities-for respective registration; licensing authority-
for obtaining industrial license etc.
4. Once all the required authorizations and sanctions have been obtained simultaneous
action is to be taken for the following:
i. Ordering machinery from suppliers.
ii. Obtaining utilities like power and water connections after constructions.
iii. Recruitment of staff.
iv. Arranging supplies of materials.
v. Arranging for distributions of the product.
5. The plant is ready for commissioning.
 Trial run may be made
 Promotional work may be made
On the basis of feed back obtained, the process or product has to be modified until
acceptance out put is obtained.
6. The unit is then ready for commercial production.

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