How small firms could help build sustainable economies

Beyond their sheer numbers, small and medium businesses offer significant benefits to their communities, their employees, and the entrepreneurs who lead them–individuals driven by purpose, autonomy and control. 

“They provide personal projects that individuals can control, invest in, develop, grow and see to fruition. This enables deep satisfaction that’s often missing when working for large conglomerates,” Eaglin said. 

“We should seek to learn from them.”

SMEs rely on debt and efficient asset utilization

To understand how SMEs work, we should consider two important features, Eaglin said.

• Around 70% of small firms are financed through debt;
• They focus on efficient asset utilization.

“They take assets that others have developed and try to use them as best they can,” he said. “And those firms that figure out how to better manage debt and asset use are more likely to generate outsized rewards that are more sustainable.”

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A case-study: The minibus taxi industry in South Africa

The minibus taxi industry offers an illuminating example of how debt and asset utilization impact business strategies and success, Eaglin said.

In South Africa, this industry provides daily transport for over 15 million people daily and is the primary mode of transport for 80% of its population. The firms are privately owned and operate with little regulatory oversight, with no public subsidy or planning from the government, he said.  

“And yet, despite failures in health, water, and education for the disadvantaged population in South Africa, the minibus tax industry gets up every day and gets the country going to work,” Eaglin said. 

In addition to providing this service, the minibus taxi industry offers one of the few pathways to social mobility for the historically disadvantaged population, which in South Africa is penalized by conditions of high unemployment, he said.

Eaglin studied the industry using a proprietary data set from a South African minibus taxi financing company, with a portfolio of about 50,000 vehicles, representing between 14% to 20% of all the taxis on the road.

This company provides financing and insurance to their clients, he said. They also place a GPS device in each vehicle that collects locational data every six seconds, producing trillions of observations on drivers’ behavior — a proxy for how these small entrepreneurs use their assets, Eaglin said.

By analyzing these data and combining it with surveys and interviews, Eaglin detected two patterns: 1) High interest rates drive strategic misconduct; 2) How debt interacts with asset utilization.

High interest rates drive strategic misconduct.

Eaglin defined “strategic misconduct” as “the sets of actions that firms undertake to be profitable while breaking the law,” Eaglin said.

Specifically, Eaglin found that as interest rates go up, so does the average speeding over the life of the minibus taxi.

“The minibus industry in South Africa is known for driving very quickly and quite recklessly. And when you talk to minibus taxi owners, they will tell you one of the primary reasons why they do this is because they have an excessive debt burden. They have really high interest rates and high monthly installment payments, and it's difficult for them to meet them,” he said.

A “violent” national strike by the taxi industry in 2017, that resulted in a relaxation of their debt burden, confirmed how debt affects the industry, Eaglin said.

In the aftermath of the strike, the financing company lowered interest rates by two percentage points. The impacts were substantial: taxi operators decreased speeding by about 10%, which also led to a 12% decrease in collisions over the next 18 months, Eaglin found.

“Debt relaxation can increase the likelihood of firm survival, and also increase social welfare — in this case, safety,” Eaglin said. 

How debt interacts with asset utilization.

In collaboration with the financing company, Eaglin designed a “debt rehabilitation” experiment. They modified contracts for indebted taxi operators, offering them various options. 

The experiment resulted in a 10-13% improvement in repayments, Eaglin said, mainly driven by an increased use of their assets — their minibuses.

“They spent more days working, and went further on the days of work,” he said. 

The operators were “depressed” by the amount of debt burden, Eaglin said.  “They felt they could never pay it off, so they underinvested in asset utilization. The relief increased their ability to see their way out of this contract and therefore increased their performance.”

Why SMEs are important for economies

People interact with small and medium enterprises daily. Plumbers, carpenters, and most stores are SMEs. Eaglin added that supply chains are also relying on small businesses.

“It's not uncommon for large firms to really struggle with their supply chain because they haven't figured out how to get the best out of the small and medium sized businesses that serve them,” Eaglin said.

These small firms are located within the communities that they serve and have a keen sense of local dynamics, he said. “They can adapt to local needs much more quickly than larger firms, and they're more able to be held accountable to those in their community.”

Eaglin added that although the minibus taxi industry in South Africa is unique, the implications of the experiment can be applicable to broader economic settings.

The financing company that partnered for the experiment is a publicly traded company, he said, and “decided on their own accord that they needed to better attune their business to the way in which their operators work, in order to be more profitable.”

“In the year of the experiment, we saved this financier about 50 million in local currency– which is a really big deal.” 

Eaglin concluded that the experiment shows how debt reduction ultimately benefits the lending firms, operators, and society as a whole. 

“If you are a financier, or a large corporation working with small businesses, you should think that excessive debt burdens can lead to underperformance. Relieving these debt burdens can improve business performance, with huge implications for the quality of service, and employment opportunities within a community.”