Chapter Two

Small Business Management

 CHAPTER TWO
SMALL BUSINESS MANAGEMENT
2.1 Definition of Small Business
The small business (cottage industry) may be defined as an enterprise or
series of operations carried out only by a workman skilled in the craft on
his own responsibility, the finished products of which he markets
himself.
Small business is a business which is independently owned and operated,
not dominated in its field of operation and meets certain standard of
number of employee and capital.
capital
Generally, there are two approaches to define small business
enterprises: Size criteria and Economic/control criteria
1. Size criteria
 Sales volume – Amount of product an enterprise produce and sell in
specified period of time(usually one year)
 Number of employees
 Asset size
 Volume of deposit
 Insurance in force
 Cont…
2. Economic/control criteria
Market share
Independence
Management style
The most widely used criteria to define small business are number of employees
and amount of capital. Accordingly, the following definition is determined to
be applicable by the Ministry of Trade and Industry in Ethiopia;
 Micro enterprises are business enterprises found in all sectors of the
Ethiopian economy with a paid-up capital of not more than Birr 20,000 and
less than 20 employees, but excluding high-tech consultancy firms and other
high-tech establishments.
 Small Enterprises are business enterprises with a paid-up capital of more than
Birr 20,000 and not exceeding Birr 500,000 and with number of employees
ranging from 20 – 100, but excluding high-tech consultancy firms and other
high-tech establishments.
2.2 Characteristics of Small Business
1. Actively managed by its owner - independent Management
2. No or few management layers
3. Style of management is highly personalized. I.e. the owner has firsthand
knowledge of every move in the business at all levels and he is the main
decision maker
4. Relatively small in size within the industry as compared to the highest unit in its
field
5. Largely dependent on the internal resources of capital to finance its growth.
6. Capital is supplied by ownership and is held by an individual or a small group
7. Limited resources: a small business is unlikely to have sufficient resources to
dominate the market.
8. Independence: the owner has ultimate authority and effective control
9. Scope of operations: small enterprises serve a limited segment of local or
regional market
10. Scale of operation: they occupy a limited share of given market.
11. Labor: they are low in capital and high in labor, as they cannot afford capital-
intensive machinery.
 Cont…
12. Specialized skills: The small enterprises normally have specialized skills for
certain specific clients & does well in small, and isolated market
13. Small business does well in developing markets as it can easily absorb the
changes
14. Small business survives well in a bad business condition due to having quick
and clever capability of bringing changes in cost and labor.
2.3 Major Areas of Small Business
Small business tends to do better in some industries than in other:
1. Service business- requires a small capital investment to get started. E.g..
hotels and transportation services.
2. Retail business- buying products from whole sellers and reselling the
products to final consumer
3. Wholesale business-buying products from large manufacturers and
reselling the products to retailers
4. Manufacturing business
5. Agriculture
 Cont…
2.4 The Importance of Small Business Enterprises
a. Greater value in building up a local production structure and in
promoting economic growth
b. As a means of creating employment opportunity, and achieving a fair
distribution of nation resources, income, knowledge and power
c. A seed bed for development of local entrepreneurship
d. Promote rural industrialization
e. More appropriate technology is applied
f. Supplier of parts and accessories to bigger industries
g. Play prominent role in promoting the export market

2.5 Environment of Small Business

 Internal Environment
 External Environment
2.6 Factors that contribute to the success of small business
 Hard work, drive and dedication
 Market demand for products/ services provided
 Management competence
2.7 Common Causes for Small Business Failure
Managerial incompetence or inexperience-
Neglect
Weak control system
Under capitalization: too few funds to survive start up and growth
Failure to clearly define and understand your market, your customers,
and your customers' buying habits
Poor financial control
Over investment in fixed asset
Failure to plan current as well as future operation
Failure to adopt proper inventory control system
Improper Attitude (The entrepreneur may not respect time, employees
and may have lazy lifestyle and dictatorial style of work)
 Inadequate marketing plan
Incorrect market identification
Poor distribution channel
Poor location
Weak marketing communication or promotion

2.8 Problems in Ethiopia Small Business

 Scarcity of capital.
 Limited and unequal access to institutional credit markets.
 Irregular access to domestic and imported inputs coupled with higher cost.
 Inadequate infrastructure facilities.
 Weak managerial and technical skills.
A large number of SMEs have successfully overcome these formidable
difficulties, established a sound base in the domestic market, and may be
potentially capable of breaking into export markets.
However they may be hampered by a variety of circumstances:
 Lack of information on possible export market.
 Absence of guidance on export regulations and procedures.
 Inability to identify sources of assistance for product development and
product upgrading for export.
 Lack of information on export credit and insurance facilities as well as
for export requirements.
 Lack of information on operation of indirect marketing channels like
merchant export houses.
 Absence of guidance on basic management issues relevant exporting
firms.
 Absence of sound steps that need to be taken to enter in export field.
2.9 Setting Small Business
2.9.1 Business Ideas
A business idea is some one’s opinion regarding what may or may not be a good
business. There are three types of business ideas. They are:
Old idea – Here an individual copies an existing business idea from
someone.
Old Idea with Modification – In this case the person accepts an old idea
from someone and then modifies it in some way to fit a potential
customer’s demand.
A new Idea – This one involves the invention of something new for the
first time
Sources of Business Ideas
 Customers
 Existing companies
 Distribution channels
 Research and Development units
 Government
2.9.1 Small Scale Industry & Large Scale Industry
Definition

There are three parameters that are generally accepted, either signally or in
combination, in defining the terms in most countries, these are
 Number of workers employed which is the most widely used criteria
 The level of capital investments or assets
 The volume of production or business turnover.
In many countries, medium scale industry is not defined and is understood to
include those that fall between small and large industries
Accordingly, Small scale industry means an industry that has less capital and
employee less workforces and Large-scale industries refers to those which have
relatively substantial capital and grater annual sales turn over.
 Cont…
Advantages Associated With Small Scale Industries
o Production of consumer commodities.
o Labor intensive approach for commodity production there by
scaling down the extent of unemployment as well as poverty.
o Efficient and equitable distribution of national income
o Promotes balanced development of industries across all the
regions of the economy.
o Development of skills required for entrepreneurship
o Act as an essential medium for the efficient utilization of the skills
as well as resources available locally.
Advantages of Large Scale Industries
(1) Economies in making the goods, and
(2) Economies in marketing the goods.
1. Economies of large scale production saves in;
Capital cost per unit of product
Labor cost
Possibility of making improvements
Cost of superintendence (the act of managing/supervising/overseeing sth.)
Utilization of waste
Providing their own aids to making and marketing their own cans, boxes,
etc., and owning railways and steamship lines, etc.
2. Economies in marketing of goods;
Economy in securing trade, through advertising and commercial travelers
Economy in "carrying " stocks of goods, a relatively smaller stock being
sufficient to meet the fluctuations in demand
Economy in getting goods to consumers, through the power to secure
better freight rates for large shipments, and through the power possessed by
some concerns to avoid "cross freights”
Economy in securing a foreign market, through the greater power of the
large concern to withstand the cutthroat competition common in "hard
times."
 2.9.2 The Start up Process of a Small Enterprise

Starting a new business requires the following steps:

STEP 1: Identification of New Venture Opportunities
STEP 2: Evaluation & selection of New Venture Opportunities
STEP 3: Technical, Marketing & Financial Feasibility of the Project
STEP 4: Assessment of Personal Requirements & Org. Capabilities
STEP 5: Analysis of Competition
STEP 6: Developing Action Plans
STEP 7: Implementation and Evaluation
STEP 1: Identification of New Venture Opportunities:
In the search for new ventures, entrepreneurs explore both external and internal
sources.
The external sources include:-
1. Newspapers, trade journals, professional journals etc. which tell about
trends in fashions, customs and other social areas.
2. Professional magazines catering to particular interests such as electronics,
computers, and oils etc.
3. Trade fairs and/or exhibitions displaying new products and services.
4. Government agencies.
5. Ideas put forth by others.
Internal sources basically consist of storehouse of knowledge build up by an
individual over the years. An entrepreneur draws upon it and undertakes the
following exercise:-
a) Analysis of concepts in the light of existing problems and their capacity to
solve them.
b) Search of memories to find similarities and elements related to the
concept and its problems.
c) Recombining the elements found in new and useful ways.
Sources of Ideas for New Products
Necessity: identification of potential customer needs & tailoring the
product and services to meet them.
Hobbies/ Personal Interest
Watching Trends in Fashions and Customs
Observing other’s Deficiencies; eg. Devt of a key that will identify a
person
Gap Filling
Novel Use of Known Products; new uses of existing products etc,..

STEP 2: Evaluation & selection of New Venture

Opportunities
While evaluating the major points to be considered are:
Technical feasibility that is the possibility of production with the
available skill & technology
Commercial viability of the idea based on cost and profitability. It
evaluates the tradeoff between cost and income to judge the attractiveness of a
business idea
Pitfalls in Selecting New Venture Opportunities
1) Lack of objectivity: Some entrepreneurs get so obsessed with their idea that
they overlook the need to scrutinize its feasibility. No wonder such projects end
up as failures.
2) Market Myopia: A shortsighted approach of concentrating on production rather
than on marketability could lead to un avoidable disaster. An entrepreneur may
fail to properly assess the market acceptability of his product. Selection of the
right time for introducing the product is important for its success..
3) Inadequate Understanding of Technical Aspects: Technical difficulties
involved in the production of a product are a time consuming and thorough job.
Inexperience in this area can prove quite costly and swamp a budding
enterprise.
4) Lack of Product Differentiation: To capture the market, the product should
have distinctive characteristics in terms of design, utility and other features.
Assured superior performance over the products is essential to provide it a
competitive edge.
5) Overlooking Legal Issues: A smart entrepreneur should be alive to meeting the
various legal requirements. For instance, workers should be provided with
legitimate legal dues, consumers are provided with reliable and safe products,
copyright, trade mark etc. should be observed.
STEP 3: Technical, Marketing and Financial Feasibility of the
Identified Project
A. Technical Feasibility: covers the following
1. Identification of critical technical specifications;
a) The functional design of the product.
b) Adaptability to the new customer demand.
c) Durability
d) Reliability of performance
e) Safety
f) Reasonable utility (i.e. acceptable level of obsolescence)
g) Standardization (i.e. elimination of unnecessary variety)
2. Examination of product quality-cost relationship:
 Understanding that there are tradeoffs b/n technical excellence &
associated cost i.e. a positive relationship exists between technical quality
and costs.
3. Product testing, which includes:
a) Engineering studies relating to machines, tools, instruments work flow
etc.
b) Product development through blueprint, models, prototypes.
c) Product testing through laboratory testing and field-testing
B. Market Feasibility
1. Identifying the Market Potential
 Specific end users,
 Major market segments, and
 Potential volume of purchases within each market segment.
2. Estimating Cost-volume Relationship to ascertain how various price levels
may affect total sales volume. The price must reflect the value of the product.
The entrepreneur may not adopt a uniform price structure to take care of the
sensitivity of the buyer to price changes. The cost-volume analysis would also
facilitate the determination of appropriate economies of scales i.e. optimum
size of enterprise, which has lowest average per unit cost of production and
distribution.
3. Sources of Market Information: Relevant data for market analysis can be
gathered from two main sources viz (a) primary sources such as interviews,
mailed questionnaire, survey etc and (b) secondary sources like government
agencies, trade unions, chambers of commerce etc. Whereas the former is
costly, the latter may not meet the requirements of the entrepreneur.
The following kind of data matrix may be quite helpful:
 Data relating to general economic trends as revealed by various indicators
such as new orders, house activity, inventories consumer spending.
 Market data relating to demand pattern, seasonal variation etc.
 Pricing data i.e. range of prices for same, complementary and substitute
products; base price; discount structure etc.
 Channels of distribution both wholesale and retail.
 Data relating to competitors.
To obtain this data, the entrepreneur may either conduct his own survey or
approach a consultant.

4. Market Testing: It is an important method of establishing the overall feasibility

of a new venture, significant market testing methods include:
o Displaying the product at trade fairs,
o Test marketing to analyze the receptivity of the product, and
o Sample sales.
C. Financial Feasibility
It covers the following:
 Determination of total financial requirements
 Financial resources and other costs: financial resources could be
categorized on the basis of periodicity into:
 Short term resources: (those payable in a year). Trade credit supplies,
short term loans from banks or other lending institutions, sales of account
receivable etc. belong to this category.
 Intermediate term Loans: Intermediate term loans are those available for
one to three (sometimes five) years. It includes terms loans from banks,
lease finance, financial assistance from institutions etc.
 Long-term loans are those from banks, equity capital and investments of
earnings.
 Cash Flow Analysis
Net Cash Flow = Cash inflow – Cash outflow
STEP 4: Assessment of Personal Requirements & Organizational
Capabilities
A) Activity analysis; identifying the total range of activities and level of skills
B) Grouping the activities into set of tasks that individuals can handle effectively.
C) Categorization of various tasks to form the basis of structure of organization.
D) Determination of interrelationship between different positions and designing of
organizational hierarchy.

STEP 5: Analysis of Competition

Generally, every organization faces two types of competition:
 Direct competition from similar products.
 Indirect competition from substitutes.

STEP 6: Developing Action Plans

No strategic plan is complete until it is put in to action. To make the plan
workable, the business owner should divide the plan into projects, carefully
defining each one of the following:
 Purpose: What is the project designed to accomplish?
 Scope: Which areas of the company will be involved in the project?
 Contribution: How does the project relate to other projects & to the overall
strategic plan?
 Resource requirements: What human & financial resources are needed to
complete the project successfully?
 Timing: Which schedules & deadlines will ensure project completion?

STEP 7: Implementation and Evaluation

Now it is the time of reality. When action plans are materialized according to the
action plan which is composed of various projects, business plans are
considered to be implemented.
After implementation, evaluation follows. Evaluation is mainly concerned towards
ensuring the achievement of mission, objectives etc.
2.9.3 Field Problems of Starting a New Enterprise
(1) Pre-operator problems
o Problem of selecting an appropriate form of business organization.
o Problems related with the acquisition of basic facilities such as sources of
raw materials, power, transport etc.
(2) Problems during the construction phase.
 Acquisition of land;
 Construction of building and other aspect of civil works;
 Acquisition of machinery and its installation;
 Preliminary work about the sources of supply of raw materials , labor and
managerial inputs;
 Prospecting about marketing;
 Preliminary work regarding sources of working capital;
 Coordination problem connected with the acquisition of different kinds of
assets or completion of jobs;
(3) Post Operative Problems of a New Enterprise
 Lack or absence of profits
 Experience Factor:
 Unfamiliarity or lack of experience in product or services line.
 Lack of experience in management. There is a vast difference between
being a machinist and being able to manage a machine shop.
 Over concentration of experience .e.g. .focusing only on the area of
interest says, sales, finance, production etc and neglecting others.
 Incompetence of management.
 Sale Causes
 Weak competitive position ;
 Lack of proper inventory control;
 Low sales volume ;
 Poor location ;
 Decline in demand due to recessionary trends in the particular industry ;
 Inappropriate marketing strategy ;
 High production costs and consequent high pricing ;
 Expense Causes i.e. failure to control operating expenses that reduce profit and
Pose a threat to survival of the firm. For instance, borrowing too heavily may
force business to close if debts cannot be timely paid;
Neglect Causes: Common Cases of neglect are; poor health, laziness,
family or manage Problems. Entrepreneurs need to establish priorities for
themselves relative To their involvement in the firm. They must
concentrate on objectives of the Firm.
Capital Causes
o Low or over estimation of capital needs;
o Fund mismanagement ;
o Cash losses;
o Poor debt collection or unfavorable credit terms.
 Customer Causes .i.e. extension of credit on liberal terms.
 Personnel Causes.
High rate of absenteeism &/or labor turnover
Unhealthy industrial relations
Frequent strikes and lockouts
Low productivity
Militant trade unions
 Natural calamities such as burglaries, earthquake .fire etc...
 Government Regulations.
 Difficulty of compliance due to excessive cost burden;
 Interference and dilatory tactics adopted by government authorities.
 Unmindful expansion so that sufficient business is not generated to sustain
expanded capacity.
 Environmental Causes
Changes in government policy ;
Changes in social or political conditions ;
Inflationary pressures leading to increases in the input cost.
 Production Causes
 Technological obsolescence;
 Low capacity utilization;
Inability of labor to correctly understand technology;
Non-availability of spares and replacements;
Poor machinery maintenance;