Funneling support to promising enterprises in developing countries

Loreto, Peru.- Peruvian entrepreneurs work developing products from the agro-industrial and aquaculture fishing sector in Loreto, Peru on September 3, 2020. The Peruvian economy plummeted 30.2% in the second quarter of the year, a figure that represents one of the greater falls of the GDP since there are historical records. This figure places the country among the most affected in economic terms in the world, according to the National Institute of Statistics of Peru (INE).

Dulani Chunga, a Malawian business owner, has risen from rags to riches. He started with an entrepreneurial spirit but no capital, with loads of practical experience working small jobs but no formal degree. He had little support to meet the countless challenges he faced in growing his business making coffins for export. Dulani’s story is a common one. Entrepreneurs in developing countries face both supply- and demand-side constraints. Access to finance and information remain high hurdles, as do the lack of educated workforce and entrepreneurial capabilities.

The problem is that most support programs tackle only one constraint at a time, be it upgrading firm capabilities or access to finance and—rarely—to markets. In a new paper, I document the experimental evidence gathered to inform the design of the Financial Inclusion and Entrepreneurship Scaling project in Malawi. The study proposes a novel approach to “funnel in” the most committed and high-potential entrepreneurs.

Unidimensional support programs offer useful lessons

Programs that improve access to finance usually have positive effects on capital investment and employment. But initial conditions matter, and so do the size and mode of financing. For instance, large grants provided through a business plan competition in Nigeria’s YouWin! program had positive effects on the probability of starting a new business, firm survival, sales, profits, and innovation. For microentrepreneurs in Ghana, in-kind grants had larger and more significant positive effects on profits than cash grants.

Dulani applied for and obtained a business loan, but his flourishing coffin export business nearly collapsed a few months after he got the money. What went wrong? Access to finance may be necessary but seldom sufficient for success. Entrepreneurs often lack the knowledge to efficiently combine finance with other inputs. To this end, firm upgrading programs can complement finance. Some lessons from training programs include:

  • More experienced firms increase sales relative to less-experienced ones.
  • Female-led firms appear to benefit from some training programs, e.g., those that strengthen personal initiative skills.
  • Direct consulting services can be more successful than formal classes.

Interventions that address multiple constraints are more effective

Firms often face multiple constraints. If, for example, training fails to deliver results, it is not necessarily because the training is ineffective but because firms may have other binding constraints. For instance, the business plan competition YouWin! showed that skills training by itself is not effective. But interventions that attempt to jointly address constraints to skills and financial access have positive impacts. Experimental studies in Tanzania and Uganda that offered both business training and grants to firms were successful in improving firm performance in terms of sales and profits relative to a program that did either training or grant alone.

Although support programs establishing demand linkages are successful, they are seldom implemented. Buyer-supplier relationships are subject to problems of information asymmetry, moral hazard, coordination failures, externalities, and spillovers, along all stages of the supply chain. Interventions that improve access to more sophisticated customers (e.g., multinational companies) or markets in general by providing vouchers to buyer firms can help firms expand. A supplier development program in Chile has been effective in enhancing firm sales, employment, wages, and the survival probability of small suppliers by dissemination of information, opportunities for expanding networks with buyers at fairs, as well as missions and conferences. Positive effects on firm performance are also found from the “Productive Linkages” program in Costa Rica, export promotion programs in Egypt and public procurement programs in several sub-Saharan African countries.

A ‘funneling’ approach can address multiple constraints

This approach has been successfully experimented in some advanced countries and is being implemented through World Bank projects in developing countries. In 2020, the World Bank approved a tiered firm support program in Malawi through the Financial Inclusion and Entrepreneurship Scaling (FInES) project. The program starts by providing generic training programs including personal initiative skills and light-touch mentoring to a large number of small and medium enterprises (SMEs). Firms that show improvement—as measured by an objective assessment after the program—graduate to the second stage. This stage offers specialized business skills training and one-on-one consulting. Firms successfully completing the second stage are filtered into the third stage that enables market access and financial support (Figure 1).

Figure 1. FInES in Malawi sequentially builds capacity and addresses finance and demand constraints

Figure 1. FInES in Malawi sequentially builds capacity and addresses finance and demand constraints

The funneling approach is flexible such that the exact intervention at each stage can be adapted to the country context. For example, the Economic Linkages for Diversification (EL4D) project in Mozambique is following this tiered approach to strengthen the performance of firms by developing upstream linkages with large corporates in the lagging regions of the country—while addressing and mitigating some of the drivers of fragility and conflict. The three stages of interventions are illustrated in Figure 2, where stage 1 offers a variety of firm capabilities’ training and mentoring, while stage 2 focuses on quality standards and procurement processes for about 30 percent of those supported in stage 1. Finally, stage 3 facilitates linkages of upstream suppliers with larger firms and offers matching grants to up to 10 percent of the firms initially supported.

Figure 2. EL4D in Mozambique improves firm capabilities, access to finance, and linkages with big buyers

Figure 2. EL4D in Mozambique improves firm capabilities, access to finance, and linkages with big buyers

Such an approach has the advantage of offering inexpensive assistance to large numbers of firms, while restricting the most expensive, knowledge, and time-intensive parts of the program to firms that demonstrate higher levels of engagement and improvement. The funneling approach is being considered in other World Bank projects, but there is still a lot to be learned through experimentation, evaluation, and complementary capacity building.

A reassuring takeaway from the recent experiments: Well-sequenced and carefully implemented tiered support programs can potentially offset multidimensional market failures and help future Dulanis rise to riches.