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Posted on October 31, 2016

Six secrets of the self-employed

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Findings from the Kenya Financial Diaries Update

This is the second post in a three-post blog series introducing publications from our recently concluded Kenya Financial Diaries update study, conducted with BFA.  The first paper is here.  This second paper, Small ‘b’ Biashara, can be downloaded here.  The third paper will be released next Monday. Stay tuned!

Close to 1 in 4 working Kenyan adults derive a majority of their income by working for themselves in non-farm activities rather than for an employer that pays a salary or wage [1]. With too few formal jobs to absorb Kenya’s rapidly expanding workforce and rapid urbanization, the share of the working age population in self-employment is growing faster than in farming or wage work [2]. A recent survey of micro, small and medium enterprises (MSMEs) in Kenya [3] estimated that out of a total of 7.4 million MSMEs, 98 percent are operated by their owners, with few or no employees, and 80 percent are unlicensed [4] – that is, operating without a business permit from the county government. 

In our study assessing the changes in well-being of Financial Diaries respondents between 2013 and 2015, many told us that starting or growing their own businesses was a major reason behind improvements in their economic situation. Given the broader labor market context and the importance Diaries households ascribed to self-employment in their own lives, we decided to explore this topic in more depth.  Why does self-employment seem to be so strongly correlated with improvements in well-being? How do these small businesses start and grow?  What role does the financial sector have in supporting them?  How might it do more? 

Here are six secrets we uncovered in the process:

The overwhelming majority start with very little capital. The median business run by a Diaries household started with just KSh 600 (about $6).  Three quarters of businesses started with less than KSh 5000 (about $50).  Most business start-up and expansion is funded with savings and gifts from friends and family.  Formal credit today plays a relatively small role for these tiny operations.  But the fact that anyone can start a small business with very little money and without having to undertake formal registration makes them a very powerful option for families needing to supplement their earnings.

Few constitute a fully independent livelihood. The median business earned only about KSh 1500 ($15) per month in profit during the months they were active during the Diaries.  The mean rose to KSh 4,791 ($48), but only 11.5% of any of our registered businesses produced an average monthly profit of KSh 10,000 ($100) or more, the median amount that our respondents reported that their households would need to earn in order to live comfortably.  Instead, business people, like other Diaries respondents, piece together a survivable income from many different sources, often including multiple businesses. 

Businesses are low tech and low productivity. Diaries households sell the things that people around them need to buy, which is mostly food (basic staples, fruits, vegetables, and cooked snacks like mandazi, tea, and chapatti) and transportation (via motorbike or hand-drawn carts).  They employ little technology and rarely differentiate their offerings from others in the market.

When businesses grow, they do it through diversification not specialization. When an entrepreneur grows his or her business, it’s usually through diversification (like adding a kinyozi/barbershop next to the posho mill or an M-PESA agency next to a small restaurant) rather than specialization and expansion to a larger market

Markets, not finance are often the biggest barrier to growth. There are some moments when these businesses need money to grow, but often the bigger constraint is customer volumes and spending power.  There are only so many bananas, chapatti, and motorbike rides that can be purchased in a given community.  Undifferentiated products cannot be easily or successfully exported elsewhere.  The chart below diagrams the typical growth trajectory of Diaries household business, many getting stuck at the bottlenecks described.  To enable real growth, low income households need to be able to fit their businesses into larger markets, not just to borrow money. 

Small business is often aspirational and preferred to employment. Diaries respondents told us that running a business provides a feeling of pride, success, and confidence.  Those who have jobs still aspire to be able to run businesses one day.  Others told us that starting a business helped them feel more fulfilled and capable.  Even when returns are small, starting a business is a success you can claim for yourself. 

Small enterprises like those in the Financial Diaries sample are a small representation of a much larger force in the Kenyan economy which channels the energy, skills and dreams of an increasing share of a young population.  These small enterprises are a powerful force for reducing vulnerability and providing a livelihood to many.  So, even as policymakers and financial service providers support the emergence and growth of larger, more productive, formal firms, it’s important to continue to leave space for these kinds of businesses to thrive. 

Development partners like FSD Kenya need to grapple with the question of how best to support this growing segment of the Kenyan economy. How can we help entrepreneurs both drive economic growth and capture its benefits? How can we help them leverage the opportunities created by new technologies? How can we protect entrepreneurs from the kinds of risk that may deter specialization and the increased productivity that accompanies it? As we work to enhance inclusive growth, how do we ensure small enterprises are part of that story and not crowded out?

[1] In the 2016 FinAccess household survey, 40% of working (non-dependent) adults reported farming as their primary source of income, 15% reported employment and 23% reported casual work.

[2] 2012 Kenya Economic Update

[3] 2016 Micro, Small and Medium Enterprises ( MSME) Survey Basic Report

[4] About 2 in 3 of these unlicensed business are in wholesale and retail trade, repair of motor vehicles and motorcycles.

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