Recent research into small smmes and specifically the difference between the formal and informal sectors of small business has resulted in even bigger questions now being asked by those of us who support these sectors.

Questions from the government may be how to distribute the funding and resources being made available to the small business sector? How regulate and tax the informal sector? - and if the formal sector is seen as producing more in terms of tax but the informal sector contributes more towars the GDP then where should the government be focussing its resources. Although the easy answer to this is probably on the both these sectors, the practical aspect of how this is done may be much more daunting.

From a business support perspective this also leaves organisations like ours with some serious questions to ask ourselves, not only in terms of services provided but also as far as market demands, marketing and the delivery of our services.

If you are a B2B organisation then by now you may be realising that its not only the government and business support organisations like SABusinessHub who is challenged with this problem but every organisation, formal or informal who is looking to increase its market share.

Let us know what your views are on this.

Ben

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Barrie Terblanche reports for Business day from Johannesburg

NEW research into small business reveals a quantum leap between formal and informal business. The researchers set out to plot small businesses in Gauteng along a "continuum" of business sophistication, but instead found two very distinct plateaus: informal, low-turnover, minimal job-creating businesses, and businesses which achieve substantial turnovers and create jobs.

Instead of a gradual continuum connecting these, there seems to be a quantum leap between the two levels, suggesting that there is a huge hurdle that must be cleared before graduating from the informal to the formal sector.

This has profound implications for government small business support policy and ideas such as the "first and second economy" analysis. On the one hand, it provides a strong indication that there are indeed two very distinct types of economies. On the other, it shows just how different the two economies are, and also suggests that absorbing the second economy into the first through small business development is no easy task.

The Gauteng Enterprise Propeller, the province's small business development agency, commissioned Finmark Trust -- a policy development organisation which aims to promote access to financial services for the poor -- to profile small businesses in the province.

A total of 6000 households were sampled and 12422 adult contact interviews were conducted, from which 2001 businesses were identified and examined through a 50-item questionnaire.

The result is probably the most comprehensive small business survey conducted in SA.

It shows that one in six Gauteng adults runs a business. In traditional terms, 64% of them are informal, 18% are sole proprietors, presumably formal, although the researchers seem confused about this, and 17% are registered businesses.

The pioneering aspect of the research is the attempt to identify seven segments on a continuum of business sophistication. The researchers call these Business Sophistication Measures (BSM) 1 to 7. On one end of the spectrum are BSM 1 and 2, which include open-air stall traders. BSM 3 to 6 are home-based businesses, and BSM 7 are sophisticated, office- or shop-based businesses. It is unlikely the researchers got the segmentation right this first time around, but the fact that they have started thinking in finer segments of this incredibly varied community is a major step forward.

The resulting "continuum" reveals why the traditional, cruder formal-informal segmentation has been so convincing and widely used up till now. The annual turnover of a BSM-1 business is R9113 and goes up to R66597 for a BSM-6 business. Then comes the quantum leap: the average annual turnover of a BSM-7 business is R463747.

The same goes for job creation. A BSM-1 business creates on average 0,1 jobs and this rises to 1,8 jobs for a BSM-6 business. But a BSM-7 business creates 8,9 jobs.

Why the quantum leap? What do BSM-7 businesses do differently that allows them to employ so many more people and make substantial turnovers? Where do they come from? How are they formed? How can we increase their numbers?

Research into these questions is urgently required, because the answer will tell us whether our small business development and job creation strategies are correct.

So far, most of SA's small business development initiatives are broadly based on the hypothesis that formal businesses, however small, take care of themselves. The ones which need help are informal businesses, and the aim of helping them is to make them move along the continuum so that one day they become wealth- and job-creating formal businesses.

The Finmark researchers seem to agree. They recommend that "special focus should be on the needs and characteristics of the 200000 businesses in BSM 5 and 6, the zone of transition, where businesses move from sole trader status into employment-generating entities of greater sophistication".

Karon Clare, the research project manager, says this is still an assumption. The research does not show movement of businesses over time. It could be argued that, in fact, the quantum leap revealed by the research indicates that graduation from informal to formal is unlikely.

At this point a hypothesis starts taking shape that says formal businesses are started formally by people with management experience in corporations or formal family businesses. The breeding ground for formal, job-creating small businesses is therefore not the informal sector.

If this were true, an effective job creation policy would focus more on incentives for middle managers to leave their jobs and start their own businesses rather than the formalisation of informal businesses.

When grappling with these issues, it helps to ask why it is that formal businesses are able to employ so many more people.

The research provides intriguing indications: "Despite their relative sophistication, a surprising number of businesses in BSM 5 and 6 do not keep financial records."

This may be the key difference between a business that is able to employ lots of people and one that can't. On a common-sense level it is plausible. The main way in which a business measures itself is through its bookkeeping and reporting system. With a good measurement system, a business can expand beyond the owner's immediate vision.


Without books, which include a stock control system, the business owner deliberately keeps his operation small and within his immediate reach. Informal business owners hate employing others, because staff pilfering can be ruinous without the control systems of a formal business.

Could it be that the road to mass formal business creation lies through formal employment? That if someone knows the workings and structure of a formal business by having worked in one, she stands a much better chance of being a formal business owner?

Again, the Finmark research has broken new ground by being the first to research work experience and business ownership. Although not as stark as the differences in job creation and turnover, the research shows that a BSM 7 business owner has on average 40% more work experience than a BSM 6 owner.

It may well be that a further difference could lie in the kind of work experience -- an artisan may be less likely to build a formal business than someone with middle-management experience.

If formal employment is indeed the answer to formal business creation, then development agencies aimed at informal businesses should focus strongly on vocational rather than business training. Formal business developers can focus on incentivising middle managers to leave their jobs and start their own business

Terblanche is from B2b Insight, which aims to help large organisations understand small business

© 2006 Business Day