Serving SMEs: why size shouldn't matter to IPAs

Depending on the prevailing state of the overall FDI market, SMEs are either very ‘hip’, and the market segment every IPA is suddenly focusing on, or too much hassle to bother.

In this article we will look at (a) why SMEs are an attractive market for IPAs, irrespective of the current state of the FDI market; (b) how IPAs are seen by large sections of this potential target market; and (c) what looking after SMEs really means in terms of policies and IPA activities.

Why are SMEs an attractive market for IPAs?

Often, the sense that chasing SMEs is too much hassle, and it is not worth the time and effort given the number of jobs generated, seems to prevail in many IPAs. We would argue that contrary to this often heard view, it is especially SMEs that IPAs should be focusing on, for the following reasons:

(1) SMEs are the backbone of any economy: two out of three employees in Europe earn their living in SMEs. Is it really that clever to ignore two-thirds of your potential target market, for the mere hope of pulling in one of these increasingly rare, mega-projects everyone talks about (but rarely ever gets)?

(2) Not only are two-thirds of the jobs out there in SMEs, they will be the market for FDI in the years to come. Let’s face it, the big multinationals are out there already. Siemens is active in 190 countries, Nestlé in 189 and Mondelez in 155, etc. And if they are not in your country already, there is probably a reason for it. So what do you expect – that they come again?

If there is a group of companies that will internationalise in the next years – it will be smaller firms (the type that Germans call the ‘Mittelstand’). And you'd better be ready for their specific needs – because different target groups have different needs

(3) SMEs are healthier for your country. The elaborate tax avoidance schemes so popular with certain coffee chains or trendy mobile phone purveyors simply aren’t an issue with these companies. SMEs are too busy getting their production up and running to worry about systematically reducing their tax burden via multiple holding companies in several countries. Instead, they tend to pay their taxes where they earn their money. Base erosion profit shifting simply isn’t a problem with firms of 30, 40 or 60 jobs and a $3m, $5m or even $10m turnover.

(4) It may sounds like a truism, but small companies can get big. Imagine it’s 1975 and a chap called Bill Gates proposes to set up a firm in your jurisdiction, or it’s 2004 and a chap called Mark Zuckerberg calls on you – and, given that you are convinced that small firms are just too much hassle to deal with, you send them away! A decade on, you might be pretty miffed about your idea of not wanting to deal with small firms. When you fob off SMEs because they are not worth your time and effort, you always risk sending away the next Microsoft or Facebook. Are you really willing to take that risk? 

(5) Finally – and probably the most important point for IPAs – if ever there was a reason for a specialist unit to guide potential investors through the maze of investing in your country, it is to help SMEs. Put bluntly, the big corporations don’t need you. They have done this 145 times already and they know what they are doing. The most important reason for talking to you is to get a good incentive deal on top. 

Yet if a $5bn turnover company calls your ministers’ office it will probably get an appointment. If an SME rings, it will not even get past the secretary. But SMEs that are setting up their third or fourth foreign subsidiary need all the help and support they can get.

They might be a bit more work, because they are desperate to discuss all those operational questions, such as where to set up, where to outsource their tax problems to, and how to get electricity – but wasn’t that why IPAs were created in the first place?

This is the moment IPAs can shine, by bringing very real, tangible value. Why would you want to miss that opportunity? Why would you not want to focus on exactly that market?

Most IPAs, when asked what percentage of new FDI projects in their jurisdiction they supported, openly admit that they have no idea about the number of projects they are unaware of. If pressed further, they usually estimate something in the region of 25% to 40%. So there is more going on you are not aware of than there are things you are privy to.

So what do SMEs look for in IPAs?

If we ask managers of SMEs, the picture gets even bleaker. The question ‘what are your experiences with IPAs?’ often produces one of the following answers:

(1) ‘IPAs – what is that?’ It is staggering how many managers out there have not heard of IPAs, or are unsure about what exactly it is they do. And the smaller the companies these managers work for, the more likely that they haven’t heard of IPAs.

(2) ‘IPAs – no way!’ Many managers see IPAs as time wasters; civil servant types who lack any idea about the business world and who talk about grand national strategies and steal their time with standard presentations of the top five target industries, none of which is the one the manager is in. (Not to mention, not getting the practical answers he was looking for.)

(3) ‘IPAs – definitely no way!” Another alternative is the perception that IPA people are not only not helpful, but big government muscling into SMEs’ lives.

There are of course those who have worked with IPAs and value the service. But within the SME community, they are probably in the minority.

This personal observation has also been supported by academic research. Phelps (2009, page 588) found that the most important sources of information in the international site-selection process were (in order of importance): investment or merchant banks; the big accountancy firms; national IPAs; specialist site-selection firms; and general management consulting firms. 

That IPAs – dedicated institutions whose very reason for being is to support and inform investors – are considered only third best choice for corporates should make us pay attention. But that, after 2008’s crisis, investment bankers are seen as a more reliable source of information, and that the big accountancy firms, with their not unsubstantial hourly fees compared to the free services of an IPA, are considered preferable, suggests there is room for improvement within the IPA community.

And in that, the first order of the day is to be found. Most SMEs are not (yet) savvy in the internationalisation game, and most of them don’t even know that IPAs exist. So ask yourself: how easy is it for you to be found by someone who isn’t actively looking for you?

And if the overworked manager of an SME has actually found your IPA, and (not entirely sure what to expect) rings the IPA, and is treated off-handedly because it would only offer 15 or 20 jobs anyway, we might start to understand how such views come about.

Make no mistake, SMEs network among themselves, and tales of such treatment will travel far. So if you want to work with SMEs, first you will need to persuade them you are different from the rest, that you listen to SMEs and that you have solutions for them. Because, just as quickly as tales of another useless call to such-and-such IPA, the tale of Mr X in agency Y will travel through the grapevine.

What looking after an SME really means

Large corporations generally know what they are doing and – speaking to IPAs – mostly seek to maximise their incentives. However, SMEs tend to focus on getting their project up and running. Free cash on the table is nice (and usually gracefully accepted), but the priority is usually to get their foreign plant operational as quickly as possible.

Investing abroad for an SME is a huge decision and a huge risk so the crucial thing is to avoid any pitfalls along the way. For IPAs this will mean more questions, more time and more resources, but in the long run, this will be worth your while.

The starting point for an SME in assessing risk is to get a clear picture of the project’s financial viability. So the first question will be 'how much does it cost?'. And that refers to everything; wage costs, electricity rates, warehouse rents and outsourced services. Have these costs to hand – better still, on your website. The benefit to you will be more efficient meetings due to a better prepared SME manager.

A new plant in a new country also means a blizzard of paperwork: irritating if you know what you are doing, but scary if you don’t. Ensure you make the manager aware of all the necessary registrations, permits and approvals, and help him along the way. And this means not only the obvious tax and social security number registration, but also questions such as production permits for manufacturing industries run in a three-shift pattern, and customs regulations for importing used machinery.

Most importantly, hone your message to the needs of the person opposite you. Don’t torture them with your standard presentation, outlining over 15 pages why your country is a great place for agro-industry and financial services, when the SME is planning to set up an automotive components plant (while this sounds obvious, personal experience tells me it isn’t).

Don’t waste two slides of your presentation on telling them that you are ‘in a strategic location’: if they didn’t think your location was interesting, you probably wouldn’t be having the meeting. And don’t tell them you have ‘a great pool of highly qualified labour’ because everybody does, so it doesn’t mean anything.

If you believe you have a pool of qualified labour, explain why: what sort of graduates you have (again – focusing the message might help), how many of them, what is the salary level and what have these people been taught?

Don’t hand out 176-page, pristine printed ‘how to invest in’ guides because nobody will read them. This is why they want to talk to you. A good way to think about how well you are covering the ground is the ‘unknown unknowns’ game.

The unknown unknowns

Known knowns are the obvious things. The SME will need raw materials, an office or factory hall, a freight forwarder, etc, and they probably know pretty exactly what they want, but might need some help where to find these. And remember – there is a fair chance that the corporate manager you are talking to is doing this nine flight hours away from the office, so any direction you can give will be appreciated. But at the end of the day, this is the easy stuff, the things that just need doing.

Then there are the known unknowns. Firms know that they need to create a legal persona and are aware they will have to pay taxes – but how the paperwork for all of this should be filled in is probably less well known. So any help will be welcome.

If you do not know the finer points of the double taxations agreements or how the transfer pricing issue between country X and country Y is to be dealt with, you need to have expertise to hand. You need to have a network that allows you to answer even the more obscure questions, because for somebody out there, this is what really matters.

However the trickiest bit – for you and for the SME – are the unknown unknowns: those things we are unaware of. And because we are unaware of them, we will not search for a consultant to help us, or worry about it, until the problem arises.

For you as IPA, it might be difficult because it is tricky to figure out what a foreign manager doesn’t know. But this is also why your role is so crucially important for SMEs. Only by talking to you will they discover what they haven’t yet identified as a problem. And if they are made aware of things they didn’t know and can avoid a potentially costly mistake, you will have earned their trust (which means it probably is hard work from now on to still lose that project. That is where IPAs can really turn the tables).

Another good idea in this respect might be to talk to the chambers of commerce of the country where most of your investors are from, to get a sense of what is standard practice in their country. But this is masterclass level of investment promotion. The basic lesson is to pick up the phone or reply to enquiries sent by SMEs. But – again from personal experience – it is one that isn’t as obvious to everyone as it seems.

Martin G Kaspar is head of business development at a German Mittelstands company within the automotive industry and a PhD candidate at Durham University.