Despite being a major driver of growth for ASEAN economies, the majority of small and micro enterprises continue to exist outside of the formal economy.
The economic fallout of COVID-19 continues to highlight the impact of out-dated or non-existent support systems for these businesses, including basic financial instruments like insurance and access to credit. Solving that gap requires urgent attention.
There are many ways to define small businesses, but here I’m referring to those micro-enterprises with less than US$150,000 in revenue per year. In the ASEAN region, these businesses make up roughly 90 per cent of the small business community and contribute between 30 and 53 per cent of their country’s overall GDP, according to the International Federation of Accountants (IFAC).
They are heavily concentrated in rural areas, with only 13 to 22 per cent based in major cities such as Jakarta and Manila. Many also struggle with growth due to significant cash flow challenges and access to more suppliers.
Bringing SMEs into the formal economy
For decades, these small-medium enterprises or warungs in Indonesia have been forced to exist outside formal financial systems that were never designed to be inclusive. While many small business owners do not want to be recognised to avoid declaring income or paying taxes.
For the vast majority, however, it is the absence of a meaningful financial infrastructure that prevents these cash-based businesses from participating. Avoiding it, however, poses certain challenges; challenges that have been exacerbated by the pandemic, and challenges that outweigh the perceived savings.
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For example, they typically struggle to gain access to basic financial products like insurance to protect their business, or credit that can help their businesses grow. In fact, while there are more than 60 million SMEs in Indonesia, only 12 per cent are eligible to receive financing or bank loans.
Operating outside of the formal economy also means that SMEs are unable to receive government subsidies or take advantage of stimulus programs when required, as seen during the pandemic.
Expanding the scope of small businesses
Working with various supplier-partners, I have observed that small and micro businesses are often limited in their scope to the surrounding geographic area when they transact primarily in cash. This requires their customers and suppliers to make physical visits to their stores or business premises.
Handling physical currency, however, can be costly, as well as inefficient. Without a financial identity or credit history, small businesses often have to pay exorbitant interest rates on loans and other financial products from informal sources.
Simplified access to basic financial services can be a vital catalyst for small business owners to recover from the fallout of this pandemic. This is where non-bank technology or Fintechs can play a vital role by analysing alternative data-sources, building new credit-scoring models and expanding financial access without bias.
Pandemic changed consumer behaviour
The need for small and micro businesses to adopt digital financial solutions has also accelerated significantly in a relatively short period of time. In my conversations with suppliers, they see an urgent need for mobile-applications that can digitise procurement and inventory management across their retailer networks.
According to research conducted by Kantar, cash transactions have declined from accounting for 48 per cent of all purchases prior to the pandemic to 37 per cent today.
The pandemic has also dramatically accelerated the adoption of digital tools and technologies among their customers. In the past 12 months online buying and selling related search engine inquiries have increased five-fold, with more than 54 per cent and 56 per cent of new digital consumers located outside of major cities in Indonesia and the Philippines, respectively, according to a 2020 study conducted by Bain & Company.
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The study also found that monthly active users for select mobile apps have increased by 53 per cent, 43 per cent and 73 per cent in Indonesia, the Philippines and Vietnam, respectively. The technology adoption rates seen in the last 12 months as a result of the pandemic could have otherwise taken another 5-10 years. With this new paradigm, remaining outside of the formal economy is no longer viable.
Suppliers can bridge the gap between SMBs and digital infrastructure
By utilising digital tools, small and medium enterprises can now gain access to a range of vital business resources, such as accounting, financing, inventory management, eKYC, payment solutions, and insurance products.
With the right partnerships, I expect suppliers to these micro-businesses to contribute to building the ecosystem that enables businesses in their networks to further leverage these solutions to create shared value.
While working with Suppliers across markets like Indonesia, it is clear fintech can help business owners using data-driven insights and analytics to offer onboarding solutions that integrate ID verification and KYC, provide access to financing, allow businesses to establish a financial identity, and focus on growth.
The ability to automate these services and manage it online between stakeholders will ensure more of such supplier-retailer networks will benefit from digital transformation. And many fintech are already leading the way via powerful digital platforms that use creative solutions to analyse hard-to-get data-sets, provide visibility on funding and order requirements, and streamline the procurement process.
Today, SME-focused digital-lenders, for example, use AI to analyse a wider base of operational data to build a robust risk assessment that enables small business owners to access non-collateral-based working capital and build a credit profile. The same fintech also offer distribution channels for the business to avail deferred payment facilities, and make timely payments through reliable online and offline channels.
All of these resources ultimately lower the cost of doing business for small and micro enterprises, while enabling access to a broader customer base. As the cost of starting businesses goes down dramatically, I expect to see three to five times growth in the number of micro-businesses and SMEs in general.
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Collaboration is critical to success
For SMEs, fintech is fast becoming a critical partner to survival but success. SMEs are able to increase their sales by more than 40-50 per cent when they can borrow from Fintech- based lenders. Last year SMEs received 55 per cent of all loan capital distributed by Indonesia’s fintech sector, or IDR54.71 trillion, suggesting they are more willing to work with fintech platforms than traditional financial institutions.
While traditional financial institutions have approval rates for small businesses in the low teens, financial technology providers can have approval rates that are two to three times higher. Of course, no fintech alone can satisfy the needs of a growing digital economy. Collaboration within the fintech ecosystem, between fintech solution providers and banks, and with the public sector is critical.
With the pandemic serving as a catalyst for businesses to move online, remaining outside of the formal economy is no longer viable. That is why we must work together to ensure that the crucial SME sector — especially those that operate outside of major cities — have the tools to not just participate but meaningfully contribute to the GDP of increasingly digital economies for years to come.
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