Innovation In The Polish Sme Sector

Innovation in the Polish SME sector Government support programmes and the liquidity gap

Darek Klonowski

Innovation in the Polish SME sector Government support programmes and the liquidity gap

Darek Klonowski Warsaw 2009

Reviewed by: Prof. dr hab. Jerzy Hausner Dr Renata Hayder

Graphic Designer: Kotbury

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Preface

Our experiences in advising clients on obtaining funds for innovative investments confirm the basic tenet of the report, namely the limited innovativeness of Polish SMEs. This is partly due to reasons presented in the report – the access to funding is difficult, the procedures are bureaucratic, and the regulations are too complicated for a smaller investor, who may not always be able to afford professional consulting services. There is, however, one more reason why the SMEs in Poland are less dynamic in introducing innovative solutions – at present the market easily absorbs even the less innovative offerings of the SMEs. Once the market is satiated and consumers will demand more up-to-date solutions, there will be a premium on innovation. However, at present, business operations bring a profit without the risk of spending large sums on research and development of new services or products. That is why the low propensity of SMEs to take the risk is not surprising. The latest actions by the Polish Agency for Enterprise Development, carried out within the Operational Programme Innovative Economy, clearly demonstrate that the weaknesses of the system of support for SMEs have been noted and the actions to overcome them are a priority. Of the dedicated funds of the Operational Programme Innovative Economy at least 65% was reserved for the SME sector. Seeing the threat posed by competition from large companies and the high number of applications submitted by those, it was decided that some application rounds will be devoted solely to SMEs. Similarly, the products offered by the Bank Gospodarstwa Krajowego are also concentrating more on this particular group of entrepreneurs. So if we are still seeing a low rise in the number of innovative projects it may be due to business reasons, but partly also to a know-how barrier, since the application for support funds is a difficult art, which requires knowledge and experience (and SME entrepreneurs are not always ready to pay a success fee to an external advisor). It may also be due to the low levels of information available on the subject. Despite the efforts to present the government ideas on the support of innovation in the daily media, a widespread campaign aimed at SMEs is lacking.

Agnieszka Tałasiewicz, Partner Grants and Incentives [email protected]

3

Contents Acknowledgements.................................................................................... 5 Introduction .............................................................................................. 6 SME development in Poland........................................................................ 8 Innovation development in Poland............................................................. 10 Research methodology............................................................................. 12 Discussion ............................................................................................ 16

SME financing and the liquidity gap in Poland........................... 16



Structure of government support programs in Poland............... 34



Accessibility of government support programs......................... 40



Respondents’ assessment of government-support programs...... 43

Conclusions ............................................................................................ 47 Recommendations.................................................................................... 49 Endnotes

............................................................................................ 52

Appendix A: T  he size of a potential government financing to support the development of the polish SME sector...................................... 53 Tables and figures.................................................................................... 55 References ............................................................................................ 56 Our reports ............................................................................................ 58

Acknowledgements The author wishes to thank the reviewers for their helpful comments.

5

Introduction

The role of SMEs

Support programmes

Small and medium-sized enterprises (SMEs) play a key role in shaping national economies throughout the world. They are a source of growth and innovation in the industry for owners and provide jobs for citizens. SMEs are believed to offset economic declines and help restructure the existing industry. A healthy SME sector is critical to the economy and imperative to economic growth, for several reasons. Firstly, six out of every ten new jobs are created by the SME sector. Secondly, SMEs are spearheading an industrial transformation from traditional industries to the high technology sector (Dibrell et al., 2008; Freel, 2003; Audretsch, 2001). Thirdly, SMEs are at the forefront of developing innovations that have a clear competitive advantage (Low and Chapman, 2007; Audretsch, 2001). Finally, these firms are making significant inroads in the developing global markets (Salvato et al., 2007; Acedo and Florin, 2006; Karagianni and Labriandis, 2001; Lituchy and Rail, 2000). SMEs are, however, vulnerable and very few manage to survive for more than five years. Public authorities throughout the world, recognizing both the importance and fragility of the SME, have created agencies and set up numerous venture development support and assistance measures (see Di Giacomo, 2004; Secrieru and Vigneault, 2004; Karsai, 2004; Mason and Harrison, 2004; Cumming and MacIntosh, 2002). These researchers have confirmed that government assistance has boosted the employment growth of firms, they have found that soft financing programs have positively affected small firms’ survival and performance, and they have reported assistance impacts on productivity growth. Public intervention is based on the assumption that significant imperfections exist in the market place, which preclude the private sector from correcting these market distortions (Di Giacomo, 2004; Secrieru and Vigneault, 2004; Cumming and MacInotosh, 2002). These imperfections are especially pronounced in the area of finance provision to the SME sector. Despite the importance of comprehensive public assistance programs, a thorough analysis of such initiatives in Poland has yet to occur. Limited studies focus on assistance to the SME sector (MazurekKucharska et al., 2008; Borozan et al., 2005; Grabowski et al., 2003). These studies were prepared prior to the initiation of major new programs by the Polish government. They drew similar conclusions. Firstly, awareness of government support programs among Polish entrepreneurs is very low – only 30% are actually aware of them. Secondly, and as a consequence of the first point, a relatively small number of firms actually use the services (13% - Grabowski et al.,

Introduction

2003). Researchers have found the usage rate surprisingly low given the actual and declared needs of the young SME sector in Poland. The use of assistance services was also below European comparables. Most requests for assistance were made on a one-off basis; there was little requested in the way of continuous service. Thirdly, respondents declared a high level of satisfaction with the obtained services. Goals

The primary purpose of the study is to address the need for further understanding of the role the Polish government plays in stimulating innovation in the Polish SME sector. The research study is important for at least four reasons. Firstly, the project aims to provide a comprehensive evaluation of the Polish Government’s most important policy instruments. Such an evaluation is expected to show the extent to which the government is able to fill the gaps in the market place and the extent to which the available programs complement each other. Secondly, it aims to provide recommendations on the provision of assistance to the SME sector in Poland. These recommendations are based on an analysis of the capital needs of the SME sector, an evaluation of the available know-how assistance programs aimed at helping the SME sector, the perceived effectiveness of these programs, and the accessibility of these programs to entrepreneurial firms. Fourthly, the Polish program (if successful) may serve as a blueprint for less-developed countries in the CEE region, such as Romania, Croatia, Serbia, and Bulgaria. The structure of the document is as follows. Section 1 concentrates on issues related to a review of the respective literature. This section includes descriptions of entrepreneurship and the SME sector, innovation, and government support programs. Section 2 focuses on methodological issues. It outlines the project design and three hypotheses related to the financial gap, the structure of government assistance programs, and the actual use of the programs. Section 3 discusses the results of the study and summarizes informal discussions with respondents from the SME sector and Polish commercial banks. Section 4 focuses on conclusions and recommendations. Five recommendations are made to increase the effectiveness of SME support programs in Poland.

7

SME development in Poland The description of the Polish SME sector (below) is based on information from 2006 – this reflects the fact that limited changes occur from year-to-year in the dynamics of the Polish SME entrepreneurship.1 According to data from the Polish Statistical Yearbook 2006, 1.72 million firms were active in Poland (please note that more than 3.5 million firms in Poland maintain registration under the official register of businesses, REGON). Micro firms (defined as those with 0 to 9 employees) accounted for the largest pool of firms - 1.65 million - while small firms (10 to 49 employees) and mediumsized firms (50 to 249 employees) accounted for about 58,826 of the total number. The most widely-accepted definition of a small enterprise is a firm with fewer than 50 employees; while the small sector is defined as all firms with fewer than 250 employees. Collectively, the SME sector is defined as all enterprises with fewer than 250 employees, which by definition includes micro firms. There are 2,981 large enterprises in Poland; each has more than 250 employees. SME figures

As illustrated by the statistics in Table 1, the SME sector is the engine of the Polish economy. The SME sector, as defined above, accounts for 99.8% of all firms in Poland. Total employment in the SME sector is 5.9 million employees, or 70.1% of all workers employed; with micro and mediumsized firms as the largest employers (micro – 3.5 million people; mediumsized – 1.4 million people). About 35% of all the employment in the sector comes from the retail sector. The Polish SME sector makes a significant contribution (47.7%) to the national GDP. It also accounts for more than 60% of the total revenue generated by all firms. The total investment commitment of the SME sector is equal to $17.8 billion,2 of which 85% includes land and buildings as well as investments in new machinery and equipment. Purchases of used equipment account for about 10% of the total. Less than $1 billion of the total investment includes investments in research and development. This expenditure equates to 0.68% of Poland’s national GDP (including all R&D expenditures by firms, research institutes, government agencies, and universities, etc). Only about 25% of this value actually comes from the SME sector. In terms of average statistics for each type of firm, the average size of a firm in the SME sector is quite small. An average firm has annual sales of about $0.3 million, with an annual operating profit of about $0.03 million (the operating profit margin is about 10 per cent). An average firm in the sector employs fewer than four people, makes annual expenditure on assets of about $10,400 (more than 90% of this amount is dedicated to fixed assets) and spends about $600 on research and development.

SME development in Poland

Table 1: The SME sector - aggregate and average statistics from Poland. (In $ or %)

Total

Micro 0-9

Small 10-49

Medium 50-249

Large >250

Aggregate Statistics Number of Firms

1 714 915 1 652 998

44 228

14 708

2 981

Number of Employees

8 556 132 3 474 574

976 451

1 542 386

2 562 721

GDP ($ Mn)

341 945

104 977

25 645

32 484

74 886

Total Revenue ($ Mn)

825 390

205 383

109 752

181 054

329 200

36 883

4 573

4 143

9 045

19 120

Investments in R&D ($ Mn)

2 341

77

161

718

1 384

Investments in R&D as a % of GDP

0,68

0,07

0,63

2,21

1,85

585

19

40

179

346

124 249 2 481 511

Total Investments ($ Mn)

Adjusted Investments in R&D ($ Mn) Statistics Per Firm

12 309 934

110432741

Operating Profit ($)

37 986

15 534

176 206

727 495

7 035 201

Total Investments ($)

21 508

2 767

93 686

615 004

6 414 280

1 366

47

3 654

48 831

464 394

341

12

913

12 208

116 098

Revenue ($)

Investments in R&D ($) Adjusted Investments in R&D ($)

481 301

Notes: Own analysis based on various publications from the Central Statistics Office of Poland. Adjusted Investments in R&D reflect actual spending on R&D by firms. The abbreviation “Mn” indicates millions. All values are quoted in U.S. dollars in this and subsequent tables. The shaded areas refer to the SME statistics.

The most significant barometers of the strength of the SME sector are survival rate, new firm creation, and firm migration (Chmiel, 2007; Zagoździńska et al., 2008). Research by Chmiel (2007) confirms that firms from the SME sector enjoy a relatively high rate of survival (60 per cent) in their first year of operation – a statistic that has remained constant for the last few years. A four-year rate of survival is estimated to be about 30 per cent. New firm creation has been increasing steadily at an average rate of about 250,000 firms per annum, with the newlycreated firms generally focusing on wholesale and retail activities. The level of active firms in Poland is, however, steady, at about 1.7 million, which implies that the same number of firms discontinue their economic activities every year. No analysis exists that describes the velocity of firm migration from one category to another. This is one of the most important, yet often overlooked determinants of the strength of the Polish economy, as it is believed that proper business migration is the source of strong employment growth in Poland.

Survival rate

9

Innovation development in Poland

History

Earlier research

Historically, few incentives have been implemented to encourage innovation in Poland (Kijeńska, 2004). The protection of intellectual property rights operated poorly, and innovations were deemed a “social goods.” The task of innovation was centrally administered and specific industrial sectors were given priority. The cycles of innovation in these specific sectors addressed political, social and economic crises; they did not attempt to modernize, improve, and innovate. Attempts to innovate industry included importing Western technologies, such as MasseyFergusson, Fiat, and Thompson; on the domestic front, numerous research institutes were created to cover varying industrial sectors. The actual rate that these innovations transferred into the economy was poor. The period of Polish economic transformation did little to boost innovation-related activities. Fiscal restrictions have placed additional pressures on publicly-funded research institutes and universities, while the private sector was concerned with providing basic products and services to the market place. The majority of studies on innovation in Poland and in the Polish SME sector were conducted by public institutions, including the Central Statistics Office (CSO; in Polish, Główny Urząd Statystyczny – GUS) and the Polish Agency for Economic Development (PAED; in Polish, Polska Agencja Rozwoju Przedsiębiorczości – PARP). A limited number of research studies were sponsored by these institutions (for example, see Mazurek-Kucharska et al., 2008; Chmiel, 2007; Grabowski et al., 2003). The conclusions from these studies are relatively consistent. First, expenditures on innovation in Poland are fixed-asset driven. According to the CSO statistics, investments in machinery, equipment, land and buildings constitute between 65 and 85% of all declared expenditure on innovation in the last decade. Expenditure on research and development accounts for less than 10% of this amount, while expenditure on the acquisition of intellectual property accounts for about 15 per cent. The value of these acquisitions has been declining in recent years. Firms confirm that the vast majority of them do not have a department that focuses on research and development, knowledge development and transfer, or innovation. Secondly, larger firms appear to lead investments in innovation in Poland. Larger firms lead smaller firms by a factor of about five in production firms and 10 in service firms. The larger firms also introduce more products and services than smaller firms do. This stands in stark contrast to Western firms, whose innovations are predominantly generated by small firms. These firms appear more likely to work with external partners in improving products or services and internal processes. Small firms in Poland prefer to invest in fixed assets; neglecting the more traditional methods of innovation

Innovation development in Poland

such as research and development, knowledge development, and intellectual property, etc. Thirdly, Polish firms predominantly rely on their own financial resources for financing innovation. Expenditures on innovation are financed from internally generated cash flow (accounting for about 80% of total innovation financing) and bank financing (about 15 per cent). The roles of venture capital and public financing as contributors to financing innovation in firms are negligible. This problem of financing innovation is even more pronounced in the SME sector, where firms must rely on their own internal resources. Fourthly, as mentioned in the point above, access to finance is the most significant issue that hinders the development of innovation in Poland (Mazurek-Kucharska et al., 2008; Lewandowska, 2005; Jasiński, 2004; Matusiak et al., 2001). The specific points relate to poor access to finance (both debt and equity), the high cost of borrowing, and the high costs of implementing innovation (Mazurek-Kucharska et al., 2008). Secondary reasons for not pursuing innovation include the inherent high risk. Innovation management

Innovation management efforts in Poland are fragmented (MazurekKucharska et al., 2008; Piech, 2007; Kijeńska, 2004; Grabowski et al, 2003; Bramorski and Madan, 1993). In 2006, 1,085 research units were focusing on research and development. These included 313 research institutes that operated under the auspices of the Polish Academy of Sciences (in Polish, Polska Akademia Nauk – PAN) and 200 research and development centers (including laboratories, research institutes). About 573 firms from the private and public sectors declared that they conducted research and development as a part of their ongoing operations. The remaining participants included universities, service providers to research institutes, and other centers. The total number of people employed in the research and development sector in Poland was 121,283. A total of 62,250 researchers were employed in research functions, and all had at least a doctoral level of education, with 9,528 having obtained professorial qualifications. Most of these researchers were employed at local universities.

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Research methodology

Methodology

Three major hypotheses were pursued in the study. The first hypothesis relates to the existence of a liquidity gap for firms in the SME sector. It is found that access to finance is one of the major problems faced by firms in the SME sector, and that this problem places a particular constraint on their ability to increase the level of technology in their enterprises. The constraint comes from both the equity and debt markets. Research conducted by the American Milken Institute and academics (see, for example, Mazurek-Kucharska et al., 2008; Lewandowska, 2005) confirms that access to finance in Poland is behind that of other countries in the CEE region (including Hungary, the Czech Republic, Croatia, and Slovenia). The first research hypothesis is, therefore, stated in the null form below.

H1: There are pronounced liquidity gaps in the SME sector in Poland. The second research hypothesis is concerned with the effectiveness of SME support programs developed and delivered by the Polish government and its dependent agencies and organizations. Available data suggests that Polish government support programs are fragmented and based on a multi-layered approval and decision-making system (Mazurek-Kucharska et al., 2008; Grabowski et al., 2003). These programs may be inefficient and duplicate similar efforts, in that they may be very broad and dedicated to a wide variety of audiences. Consequently, the second research hypothesis is stated in the null form below.

H2: G  overnment-support programs to the SME sector are poorly structured and co-coordinated. The third hypothesis relates to the accessibility of government support programs to firms in the SME sector. Various academic studies show that Polish entrepreneurial firms struggle to operate their businesses in basic functional areas. Accounting, finance, and marketing and promotional functions seem to be the most neglected areas for firms in the SME sector. It is clear that new Polish firms need assistance in strategic management, access to finance, and in their transformation from an entrepreneurial business into a more corporate structure. While there is need for assistance within these businesses, there is also evidence to suggest that limited assistance is actually provided to the SME sector (Mazurek-Kucharska et al., 2008; Grabowski et al., 2003). New firms cannot afford to buy assistance from the private sector. The only option available to them may be to obtain assistance from the public sector. Academic research suggests an even more basic problem of awareness (Grabowski et al., 2003). Firms from the SME sector are not aware of the available government support programs. On the other hand, firms that use the programs encounter high levels of bureaucracy and procedural obstacles. Consequently, the third research hypothesis is stated in the null form below.

Research methodology

H3: Government-support programs are not accessible to SME firms. Since research into public support for the SME sector is still developing in Poland, the aim of the study was not to focus excessively on data and statistical modeling – the focus is predominantly on descriptive statistics in key data areas. The objective was to gather information through interviews with firms from the SME sector and subsequently test this against a larger population sample. For the first stage of this research, nine firms (three micro firms, four small firms and two medium-sized firms) agreed to participate in a one-hour interview. For feasibility reasons, face-to-face interviews were conducted with firms in Warsaw. The interview questions were semi-structured and aimed at discussing the innovation process employed by the selected firms (with an emphasis on innovation in different organizational areas). The interviews also aimed to cover the firms’ assessments of the government support programs aimed at the SME sector and gauge their familiarity with the programs. In two cases, criticisms of these programs were discussed due to the respondents’ familiarity with the programs. The interviews also served as the basis for a questionnaire developed for use in the latter part of the study. The sampling frame for the second phase of the study (based on the implementation of the questionnaires) consisted of 278,088 firms from the SME sector in the Warsaw region. The sample size was 500 firms from the SME sector, of which 273 agreed to participate in the study. Eleven questionnaires were subsequently disqualified, due to inadequate responses (seven questionnaires) and for being from respondents outside of the target audience (four questionnaires). Questionnaires from 262 respondents were included in the study, for an effective response rate of 52% (this is considered acceptable when compared with other studies on innovation in the SME sector). This accounted for 0.09% of the total sampling frame, making this study the largest study of SME innovation in the Warsaw region. The sample assured ±5% accuracy at a 95% level of confidence.

Sample

The Warsaw region was selected as the basis for the implementation of the study for numerous reasons. Firstly, the Warsaw region has the largest population of SME firms in Poland and represents one of its most dynamic markets. Secondly, SME firms in the region are regarded as the most innovative in Poland (according to various publications from the Central Statistics Office). Thirdly, the firms in the region are located in close geographic proximity to the central government institutions that focus on SME support programs. The Warsaw region also has the highest density of institutions that implement SME support programs (institutes, public and/or private agencies, chambers of commerce, trade organizations, and consulting and advisory firms,

13

Research methodology

etc). It was believed that the data from this pool was likely to generate a significant number of respondents with knowledge of government support programs. Operationalization

A questionnaire and cover letter were sent by mail to the owners of each firm. The questionnaire consisted of four parts and was four pages in length. The first part of the questionnaire pertained to four groups of innovation activity in the firm that could be considered important when investigating the state of innovation in the Polish SME sector – these were considered to be innovation inputs. They included 20 variables: product or service innovations (introduction of new products or services, improvements to existing products or services), process innovations (education and training of employees, business re-engineering or benchmarking, production improvement, quality management programs, information exchange, use of advanced technologies), organizational innovations (decision-making, co-operation systems with clients, suppliers, financial institutions, organizational structure, team work, decentralization, and internal communication), and functional areas innovations (marketing, supply chain management, financial management, accounting, and human resources management). In this part of the questionnaire, a five-point Likert scale was used by the respondents to rate the level of innovation activity in each category; “1” denoted limited new introductions or improvements, while “5” denoted significant new introductions or improvements. The design of the questionnaire was based on a review of literature on the subject. Other parts of this section related to intellectual property management and financial statistics as per the acquisition of tangible assets, as well as financial commitments to research and development. The second section of the questionnaire dealt with the actual results of the innovation process, or innovation outputs. This section dealt predominantly with financial indicators such as an annual growth in sales, the percentage of sales generated from new products or services, and the level of net profitability; other parts included measures of new product introductions and the firm’s competitive situation. The third section focused on an assessment of each firm’s familiarity with government-support programs. The questions related to the level of awareness of these programs and their actual use. Additional questions focused on the actual needs of firms and the reasons for applying for assistance. A five-point Likert scale was also used to understand the quality of service in two categories: key assistance areas and interaction quality measurements. The fourth section of the questionnaire was concerned specifically with the demographic data of the firms. In this section, closed questions were used to characterize the respondents and their firms. The demographic profile included questions regarding the level of sales, the number of

Research methodology

employees, the number of years in operation, the firm’s export activity, the industrial sector, and the level of the owner’s education. The study also benefited from input from the Polish banking sector, which was necessary to establish the extent of the liquidity gap in the market place for firms in the SME sector. Due to issues of feasibility, twenty-four interviews were conducted with Polish commercial banks located in Warsaw and the surrounding region. During the interviews, commercial lenders were asked open-ended questions about their banks’ financial assistance programs and their views on extending credit facilities to the SME sector. The participants were also asked structured questions about the levels of capital provided and the credit rejection rates. A part of the questionnaire dealt with profiling “preferred” firms for the banking sector. This data focused on the firm’s size, years of operations, sales level, financing needs, net profitability, and its sector of the economy.

Banking sector opinions

In addition, discussions were conducted with representatives of PAED, the Central Statistics Office, the National Trade Bank, the National Bank of Poland, and the Business Center Club. The discussions sought additional information or further clarification. Research limitations

This study has at least four major limitations and shortcomings. Firstly, the questionnaire focused on developing an understanding of innovative dynamics in the Warsaw region. The chief reason for this was to merge the data from the banking sector, the venture capital industry, and SME needs into one composite picture. Since it was only feasible to interview commercial banks in the Warsaw region, the SME study consequently had to merge data collection from this region as well (hence the orientation of this study towards Warsaw). It was also hoped that the SME sector in the region would have had more exposure to government support programs – this did not prove to be true. Secondly, since only 17 respondents indicated their use of the government assistance programs, no meaningful statistical modeling could be performed with respect to the influence of the government on the innovative propensity of the SME sector; hence, the discussions are limited to descriptive statistics. Thirdly, the government programs are relatively new. Many of the programs established in 2007 or earlier had limited market implementation, were discontinued, or were significantly amended; therefore, limiting data and implementation experience. Lastly and most regrettably, contact with the senior government officials responsible for the assistance programs did not translate into access to additional internal data and statistics. This study would have benefited greatly from such collaboration.

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Discussion SME financing and the liquidity gap in Poland Liquidity gap

Discovering the liquidity gap, or areas of the market where the private sector is unable to provide capital to suitable candidates, is a challenging task. Academics have had problems in this area of research for at least two reasons. Firstly, it can be a challenge to actually define the concept of the liquidity gap. Some researchers focus on capital shortages, while others focus on the actual nonexistence of the service. Others view the liquidity gap in terms of market imperfections, where firms are unable to connect to the “right” capital providers. For new firms, the gap means that the SME sector is not the strategic focus for capital providers (in terms of both debt and equity). Secondly, it is important to demonstrate that the firms that apply for credit actually need financing; if this were the case, the discovery of the liquidity gap could not be established on the basis of the data available from the financial sector. Access to data from demanders of capital is necessary to complete this analysis. Profitability and business growth may be used as examples of a firm’s creditworthiness. There is no tested or established method for determining the liquidity gap in the SME sector. The proposed methodology relies on combining reference data points from suppliers and demanders of capital. Amalgamating the two sides allows one to determine the extent of the financial mismatch and non-addressed financial needs (which are presented in the form of gaps in the provision of financing).

Private equity and venture capital in Poland Venture capital & private equity

Poland’s stable economy, strong growth and favorable business outlook have provided a strong foundation for an active and developing venture capital market. Since 1990, over 40 venture capital firms, financial institutions and private participants have been actively investing in Poland. The total venture capital and private equity investment in Poland between 1990 and 2007 was about $3.5 billion, and over $2 billion is still available for investment. Poland represents the most developed private equity and venture capital market in Central and Eastern Europe. This is evidenced by three major activities: fundraising, investing, and exiting. The fundraising activity indicates the attractiveness of the market to potential investors (both domestic and foreign) who are looking to efficiently allocate capital to the most attractive geographic markets. The investing activity reflects the amount of high-quality investment projects available for venture capitalists. Lastly, the exiting activity denotes the venture

Discussion

capitalists’ ability to convert their illiquid investments into cash, be it at a profit or loss. Figure 1 presents venture capital activities in Poland between 1990 and 2007. Figure 1: Key statistics (fundraising, investing, and exiting) for the Polish venture capital industry between 1990 and 2007. 1 400 1 200 1 000 800 600 400 200 0 1990

1992

1994

1996

1998

2000

2002

2004

2006

Years Fundraising

Investing

Exiting

Notes: Own analysis based on data from the European Private Equity and Venture Capital Association (www.evca.eu). See Annual Surveys of Pan-European Private Equity and Venture Capital Activity (1996-2007).

The rapid development of the Polish venture capital market has been less supportive for the Polish SME sector than was perhaps anticipated. Existing venture capital firms are growing in size and, consequently, are aiming to employ capital in larger amounts to improve deal economics. As presented in Figure 2, the average deal size has sharply increased in the last few years (from around $2 million in 2000 to almost $14 million in 2007). This confirms that venture capitalists are increasingly uninterested in pursuing smaller transactions and assisting firms from the SME sector. This is also evidenced in Figure 2, which presents investment in seed and start-up businesses (in the graph presented as “S+S”) as a percentage of total investment. The commitment by local venture capitalists to finance smaller firms has been declining from a peak of 20% in 2000, to less than 1% in 2007. Investments in expansion deals (which are likely to focus on medium-sized firms) are also on the decline (to around 13% from a peak level of above 50% in 2001).

17

Discussion

Figure 2: The average deal size in venture capital investing in Poland as well as the percentage of total capital dedicated to seed and start-up as well as expansion firms for the venture capital industry between 1999 and 2007. 90%

14

80%

12

70%

8 6

60% % Investment

10

Deal Size in $ Mln

16

50% 40% 30%

4

20%

2

10%

0

0% 1999

2000

2001

2002

2003

2004

2005

2006

2007

Years Average Deal

% in S+S

% inwestycji w ekspansje firmy

Notes: Own analysis based on data from the European Private Equity and Venture Capital Association (www.evca.eu). See Annual Surveys of Pan-European Private Equity and Venture Capital Activity (1999-2007). Abbreviated names are as follows: S+S – Seed and start-up investment opportunities; Exp – expansion investment opportunities.

Commercial banking in poland The commercial banking system in Poland is fragmented. There are 64 commercial banks in the country, of which 55 are classified as Polish-owned (there are also 581 co-operative financial institutions). The commercial banks service the general public and the business community through a network of 4,126 branches. The commercial banking sector employs about 30,000 people. The value of their total assets is estimated at about $300 billion and the value of commercial loans to the business sector is $65 billion. The growth in commercial loans reflects the commercial banking sector’s orientation towards fixed assets. While commercial banks continue to play an important role in providing finance to businesses, other sources of financing (i.e. leases, sales of various debt instruments and proceeds from the public market) have grown in importance in recent years. The available academic research on the banking sector in Poland suggests a long history of lack of support for the SME sector (Feakins, 2004; Feakins 2001). There is a strong bias in the Polish banking sector towards serving larger domestic or foreign firms (Tymoczko and

Discussion

Pawłowska, 2007; Szczepaniec, 2007). The SME sector is generally regarded by the Polish banking sector as risky and lacking management and the appropriate collateral (Feakins, 2004). Credit applications are often rejected due to poor liquidity and profitability - common characteristics of firms in the SME sector (Tymoczko and Pawłowska, 2007). In order for commercial banks to extend credit, they require strong security for their financing, which consists of a combination of registered pledges on a firm’s assets and shares, promissory notes issued by the borrower, and personal guarantees or collateral. Firms from the SME sector are not attractive candidates for financing. Reports from the European Commission (2002) confirm that Polish commercial banks are generally unwilling to fund smaller private firms if they lack an operating history, are not profitable, and have an insufficient credit rating. There is no evidence that these attitudes are changing. Twenty-four interviews (supplemented by a questionnaire) with loan officers from Polish commercial banks has yielded interesting insights about the banking sector’s preferences. Table 2 presents a brief summary of descriptive statistics for the banking sector, which outlines the lending practices of commercial banks and their general attitudes towards the SME sector. The banking sector prefers to lend larger amounts of capital to established businesses. About 67% of all loans were in excess of $2.1 million. The largest category, accounting for almost 38% of all loans, was in the $4 to $6 million range. In fact, the respondents indicated that no loan of less than $0.2 million had been granted. The banks preferred to lend to businesses with operating track records, and strongly supported those with more than eight years of operations (50.0% of the loans were provided to firms in this category). The majority of the firms served by the sector had in excess of $4.1 million in sales and a net profit of between $0.5 and $0.8 million (in the largest categories). Most dealt in construction and production (these categories accounted for 29.2% and 20.8%, respectively). The purpose of the loans, which was preferred by the banks, was to purchase fixed assets (54.2% of respondents) and working capital (12.5%). The rate of rejection for applications was high – one in every four credit applications was denied.

Role of banks

19

Discussion

Table 2: Descriptive statistics and demographic data concerning the Polish commercial banking sector’s lending preferences and loan recipients in the Warsaw region (n=24). Preferred firm’s demographics

%

Number of employees

%

Bank’s orientation

%

Capital provision

Sales levels 8,3

< 0,2

0,0

< 0,04

0,0

10 – 49

16,7

0,2 – 0,4

4,2

0,04 – 0,2

0,0

50 – 249

75,0

0,5 – 1,0

8,3

0,3 – 0,4

8,3

1,1 – 2,0

16,7

0,5 – 1,0

12,5

2,1 – 4,0

8,3

1,1 – 2,0

12,5

4,1 – 10,0

45,8

2,1 – 4,0

16,7

10,1 – 30,0

12,5

4,1 – 6,0

37,5

> 30,0

4,2

> 6,0

12,5

1-9

Credit rejection rates

Net profit

Firm’s years in operation

Banking sector

Preferred firm’s financial standing

1–2

4,2

0 – 0,4

0,0

0–5

0,0

3–4

8,3

0,5 – 0,8

4,2

6 – 10

8,3

5–6

25,0

0,9 – 1,2

33,3

11 – 15

37,5

7–8

12,5

1,3 – 1,6

29,2

16 – 20

8,3

>8

50,0

1,7 – 2,0

8,3

21 – 25

45,9

> 2,0

8,3

26 - 50

0,0

16,7

> 50

0,0

Charakterystyka preferowanych firm

%

Charakterystyka preferowanych firm Financing needs

Sector of operation Production

20,8

Fixed assets

Construction

29,2

Intangible assets

Retail and wholesale

%

8,3

Working capital

54,1 4,2 12,5

Hotels and restaurants

12,5

Marketing and promotion

8,3

Transport

12,5

B&R

4,2

Telecommunications

8,3

Export activity

Financial services

0,0

Others

Health related

4,2

Other

4,2

12,5 4,2

Notes: Own analysis on the basis of a questionnaire from respondents from the banking sector. The percentage in each category was calculated on the basis of the number of respondents in each category in relation to the total number of respondents.

Discussion

Limitations of the banking sector

The attitudes of the interviewed loan officers may be best summarized in three ways. Firstly, many lending officers are not comfortable analyzing the prospects of firms in modern sectors of the economy (i.e., Internetrelated, new technologies and biotechnologies) where limited fixed assets exist, the markets are difficult to define, and market demand is difficult to quantify. The absence of net profits almost always disqualifies potential borrowers from obtaining loans. Limited knowledge of modern sectors of the economy seems to exist within many commercial banks. Bankers prefer fixed asset-based businesses with strong profitability track records. They are uncomfortable with assessment in areas related to research and development and intellectual property management. Secondly, the banking sector appears to provide limited guidance to firms with respect to improving their business plans. If a business plan appears incomplete or is missing information, bankers are reluctant to work with potential borrowers to address these problems. The most common advice given to potential borrowers is to seek assistance from a consulting or advisory firm. Thirdly, it takes a very long time for banks to make their decisions to approve, especially for new applicants. Banks often require additional information to inform their decision-making processes and may monitor a firm’s financial performance before extending credit.

Government-support programs Since the mid-1990s, the Polish government has established programs aimed at easing access to finance for the SME sector. The programs, which offer financial assistance (loans or grants), are mainly located in PAED, under the governance of the Ministry of Economy. PAED is responsible for distributing in excess of $26 billion of capital over a wide range of programs,3 making it the largest distributor of government support programs sponsored by the EU and the Polish government.

Government support programmes

The support programs include two main initiatives aimed at developing firms in the SME sector. These focus on either the provision of relatively small amounts of capital (around $60,000) or large sums (i.e. millions) – no middle ground seems to exit. The first set of programs is specifically designed to address concerns related to financing in the SME sector and is dedicated to early business ventures. Programs include the Micro Lending Program and the Innovation Support Program. Most of these programs offer small amounts of capital (around $5,000 per project). The exception is the Bank Guarantee Fund, which provides bank guarantees totaling $6.5 million. The actual impact of these programs on the SME sector appears, however, to be relatively weak. While these amounts help the SME sector, additional conditions apply. Many of them center on specific themes (e.g. innovation, new technologies, and research and development) and only three out of 16 programs are of a more

21

Discussion

general nature. While the general intention behind these programs was to stimulate innovation, the government was perhaps hoping that the private sector (i.e. commercial banking sector) would provide more general financing. The second set of programs provides a wider scope of assistance to the SME sector - financial assistance is only a small part of these programs. Classified as structural programs, these programs include the Innovative Economy Program, the Human Capital Program, and the Development of Eastern Poland. It is important to note that these programs are offered to a wide range of potential participants and are not targeted solely at the SME sector. Potential beneficiaries of these programs may include research and development units and agencies, training centers, incubators, private/public partners, universities, and public institutions, etc. It is difficult to assess the effectiveness of these programs in supporting the development of the SME sector in Poland. With such potentially wide appeal, these programs are unlikely to fill any of their roles effectively. Seven out of 16 programs fall within this category. Consequently, the targeting of these programs to the SME sector is theoretical. The National Trade Bank (NTB, or in Polish, Bank Gospodarstwa Krajowego), which is operated under in the Ministry of State Treasury, is a state-owned financial institution that is mandated to, among other things, provide financial support to the SME sector. The specific programs offered by the NTB include bank guarantees, technology loans, pre-financing loans (for those applying for EU funding), and first-business start-up loans. The NTB is also in charge of the National Venture Capital Fund - the first public/private venture capital fund aimed at early stage technology firms. Since the establishment of this public/ private fund in 2005, two partners have been invited to co-operate, but only one venture capital deal was closed. The reasons for such slow progress vary and may relate to the unattractive terms for potential partners, strict operational and investment parameters employed by the fund and its partners, difficulty in identifying suitable candidates, and other operational issues. However, information revealed by the Fund recently shows that the next two years may bring swifter development – new managing partners have been invited and the portfolio of small and medium companies is set to grow.” A summary of the major financial programs available to the SME sector is presented in Table 3.

R&D Export General General R&D Innovation Innovation Patent Innovation Innovation General Technology Start-up UE Technology

Innovative economy (IE)

Passport for export (ED), part of IE

Development of eastern Poland (DEP)

Micro lending (ML)

Innovation voucher (IV)

Technology loan (TL)

Techno-start (TS)

Patent PLUS

Innovation creator (IC)

Cambridge PYTHON (CP)

Bank guarantee (BG)

Technology loan (TL)

First business (FB)

EU pre-financing (EUF)

National venture capital fund (NVCF)

VC

L

L

L (BG)

BG

L

L, G

L, G

G

L

G

L

G, L

L

G, L

Funding type

2005

n/a

n/a

2009

n/a

2008

2008

2008

2008

2008

2008

2007

2008

2008

2008

Program start date

SME

ALL

SME

ALL

SME

SME

ALL

ALL

SME

SME

SME

SME

ALL

ALL

ALL

Target audience

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

n/a

3M

n/a

n/a

n/a

780 M

Funding range per project($)

1.5 M

n/a

0-15,000

n/a

0-6,5 M

n/a

0-250,000

0-250,000

n/a

0-600,000

0-5,000

0-30,000

n/a

0-50,000

0-65 M

Financing per project (actual or desired)($)

Notes: Own analysis on the basis of information available from different ministries and agencies in Poland. Some information obtained from discussions with representatives from these institutions. Possible funding categories include: L – Loan; G – Grant; BG – Bank guarantee; VC – Venture capital.

Program focus

Program (abbreviated name)

Table 3: Summary of the financial characteristics of the major government-sponsored programs.

Discussion

23

Discussion

Liquidity gap The objective of this phase of the project was to assess the market efficiency of specific debt and equity market instruments in providing finance to the SME sector and, subsequently, to determine the extent to which government support programs were able to fill the existing gaps. This was to establish whether the existing equity and debt providers were able to address effectively the needs of the SME sector. The approach used in the study was to consolidate the available information from many sources to construct a perceptual map of probable capital gaps in the market place. The analysis focuses on the provision of credit from the commercial banking sector and private equity and, of course, government-support programs. Other possible areas - such as leasing, public or private debt issue, public issue, mezzanine financing, and factoring, etc. - were not included in this analysis. The perceptual map was developed on the basis of data from the venture capital and private equity community (based on desktop research available from the Polish Private Equity and Venture Capital Association and the European Private Equity and Venture Capital Association), data from the commercial banking sector (based on questionnaires and desktop research), data related to other providers of credit from the private sector (based on desktop research), and the actual needs of the SME sector (based on questionnaires and desktop research). Real needs of SMEs

As the provision of private capital (both debt and equity) has been discussed, this section of the paper focuses on an analysis of the actual needs of the SME sector. Table 4 provides an overview of descriptive statistics from the SME sector, based on an analysis from the questionnaires. In terms of financial need, firms from the SME sector require financing at two different levels. The first level appears to be at or up to $0.4 million – a tranche likely to be desired by start-up or micro firms. This level accounts for about 40% of the entire financing needs of the SME sector. The second level is significantly larger and appears to be at about $1.5 million – a tranche likely to be expected from the larger SME sector firms (this category also accounts for about 30% of the total need). The most predominant need was financing for working capital purposes (this category accounted for 35.5% of all financing needs), with the need to invest in fixed assets running second (20.2 %). Firms also declared a desire to invest in research and development (16.4%) and in marketing and promotion (14.1%). Investments in intangible assets, including intellectual property, were less of a priority (7.6%; see Table 4 for details).

Discussion

The innovation orientation of the Polish SME sector (based on the research questionnaire) confirms the aggregate macro statistics presented earlier and underlies a significant weakness in this area. About 58% of firms introduced fewer than four new products in the last three years (an average of about one new product per year). Innovation activities in other areas of the business were worse – over 65% of respondents declared that they had introduced fewer than two innovative solutions in the last three years. The low levels of innovation activity are reflected in the limited financial commitment to research and development – approximately 45% of firms committed less than $60,000 towards R&D in the last three years (this amount is still above the national average of about $36,000). Consequently, the level of sales generated from new product introductions has been low. About 60% of firms generated less than 2% of their revenues from new product introductions. Finally, 7% of respondents declared no new patents, while almost 60% responded with fewer than five.

Innovations

The demographic data presents the relative financial strengths of the SME sector in Poland. Over 90% of all respondents declared that they operated a profitable business at the net profit level and experienced strong growth in sales (almost 50% of respondents declared that their sales grew annually at between 10 and 20% in the last three years). About 33% of the respondents declared to be in business for less than four years and the majority of the firms in the sample were micro firms. Table 4: Descriptive statistics and demographic data concerning the Polish SME sector in the Warsaw region (n=262). Firm’s demographics

%

Number of employees

Firm’s financial standing

%

Firm’s innovation orientation*

%

New product introductions

Sales levels < 0,2

1-9 10 – 49 50 – 249

54,2 29,4 16,4

0,2 – 0,4 0,5 – 1,0 1,1 – 2,0 2,1 – 4,0 4,1 – 10,0 10,1 – 30,0 > 30,0

14,5

3,4 4,6 16,0 32,8 16,4 14,5 6,9

0 1–2 3–4 5–6 7–8

5,7 38,9 30,2 6,1 4,6

>8

5,4

25

Discussion

Net profit: negative

Firm’s years in operation 8,4 1–2 3–4 5–6 7–8

Retail and wholesale Hotels and restaurants Transport Telecommunications Financial services Health related

24,0

0,5 – 0,8

33,2

0,9 – 1,2

16,4

1,3 – 1,6

17,2

1,7 – 2,0

1,5

> 2,0

0,5

10,7 2,3

44,3 9,5 24,0 6,1 7,3 4,2 1,9 1,5

< 0,04 0,04 – 0,2 0,3 – 0,4 0,5 – 1,0 1,1 – 2,0 2,1 – 4,0 4,1 – 6,0 > 6,0

< 1% 1 – 2% 3 – 4% 5 – 6% > 6%

11,1 43,1 24,4 7,3 14,1

Expenditure on R&D

Capital needs

Sector of operation

Construction

51,1

24,8

>8

Production

0 – 0,4

9,9

Revenue from new products

9,2

9,2

10,7

0

53,8

21,8

0,04 – 0,08

14,1

0,09 – 0,2 8,4

12,2

31,3

0,3 – 0,4

6,1

8,8

0,5 – 0,6

4,6

5,8

> 0,6

4,2

Other 1,2

Fixed assets Intangible assets Working capital Marketing and promotion R&D Export activity Others

Number of registered patents

Sales growth*

Financing needs

20,2 7,6 35,5 14,1 16,5 4,2 1,9

0 – 5% 6 – 10% 11 – 20% 21 – 30% >30%

6,5

3,1 8,4 47,7 27,8 13,0

0 1–5 6 – 10 11 – 20 21 – 30 >30

58,0 22,1 10,7 1,9 0,8

Discussion

Firm’s demographics

%

Competitive position Worsened significantly

3,4

Worsened slightly

8,0

Remained the same

45,4

Improved slightly

31,3

Improved significantly

11,8

Notes: Own analysis on the basis of a questionnaire from respondents from the SME sector. Please note that the variable groups with an asterisk relate to the firm’s orientation in the last three years. The remaining variable groups relate to data from the last year. The percentage in each category was calculated on the basis of the number of respondents in each category in relation to the total number of respondents.

Table 5 presents a correlation matrix for some of the key innovation parameters and the demographic characteristics of the firms. A limited number of the correlation values exceeded 0.5, which indicates low multi-collinearity among the variables and a low to moderate relationship between the variables. More generally, the data indicates a moderate to low propensity to innovate among Polish SME firms. Interest in innovation is most visibly demonstrated by more mature firms; the correlation between a firm’s age and R&D expenditure is moderate (ρ=0.490). The correlations among older firms are relatively consistent. Mature firms are more effective at developing new products or services (ρ=0.454) and deriving increased sales from such innovations (ρ=0.519). Other correlations provide an interesting insight into the profiles of the respondents and their innovation activities versus their actual business performance. For example, the level of correlation between the level of R&D expenditure with new product or service introductions (ρ=0.312) and with the number of intellectual rights registrations (ρ=0.328) was relatively poor. R&D expenditure was also poorly correlated with generating new sales from research activity (ρ=0.120) and generating higher levels of sales in business activity (ρ=0.146). The results indicate that Polish firms from the SME sector struggle within two basic parameters of innovation: translating R&D expenditures into the development of viable market products or services and successfully marketing these products. Table 5 confirms that R&D expenditure does not translate into an improvement in profitability for firms in the sector (ρ=-.241). This undoubtedly relates to the high costs necessary to support continuous innovation efforts. While the costs of innovation can generally be recouped in the future, data shows that this may not be the case within the Polish SME sector; Polish firms appear unable to pass innovation costs on to consumers.

R&D expediture

The link between R&D commitment and new product or service introduction is low (ρ=0.312). There may be at least three explanations

27

Discussion

for this. Firstly, the link could suggest that Polish firms rely on other alternative methods of improving product or service offerings, rather than on traditional R&D commitments from inside of the firm. As an example, the SME firms that operate in the retail sector may actually rely on product or service improvements that were developed by suppliers. Secondly, firms may be focusing on process innovations by updating their production facilities rather than actually inventing new products. Under such circumstances, the mere existence of new machinery is likely to allow for new product development. Thirdly, the firms may be working with industry partners (e.g. universities, research centers, and agencies, etc.) on product and service development. From the perspective of intellectual property rights, registrations and inventions poorly correlate with nearly all variables (ρ<0.300), thus underlining the limited interest in intellectual property development and protection. This undoubtedly stems from weak innovation initiatives and may perhaps be further exacerbated by the weakness of the protection of Polish intellectual property rights. From a business financing perspective, capital needs or requirements seem to modestly correlate with the level of R&D expenditure (ρ=0.541) and the achievement of higher sales (ρ=0.524). Such correlation is logical, since without financing it is difficult to expect a significant and meaningful commitment to R&D and innovation. The perceived importance of key innovative drivers is summarized in Table 6, which presents a summary of the respondents’ average scores with respect to the importance they assigned to different innovation initiatives. The most highly ranked categories are discussed in this section. The most important innovation activity was found to be the improvement of existing products and services (average = 3.96). Firms in the SME sector confirm that they must continually improve their existing commercial offers to remain competitive with other firms. This is one of the key determinants of market success and ultimately translates into a strong financial performance. The high ranking of the implementation of quality management programs (like ISO) reflects growing popularity for these programs among Polish private firms and public institutions (average = 3.87). Firms perceive value in these programs from the point of view of the external validation of the market offer as well as confirmation of product or service quality and safety. The certificates are well regarded by the firms’ Western partners and are critical in distinguishing their holders from local competitors. The introduction of new products or services relates to the first point – namely, the firms’ competitiveness (average = 3.71). Issues related to distribution and logistics are ranked as the fourth most important category (average = 3.69). These issues undoubtedly highlight the difficulty of establishing an effective distribution structure for the Polish market. Supply chain management is often regarded as one of the most expensive ways to operate a business in Poland

0,149 0,312 0,187 0,120 0,146 0,065 0,317 -,023 0,490 0,541

(3)Number of patented/non-patented nnovations

(4) New product introduction

(5) Competitive position

(6) Sales from new products or services

(7) Sales

(8) Net profits

(9) Growth rate

(10) Number of employees

(11) Years in operation

(12) Financing needs

Notes: The most meaningful correlation coefficients are marked in gray.

0,328

(2)Number of property rights registrations

(1) Expenditure on R&D

(1)

0,396

0,237

0,004

0,072

-,097

0,015

0,132

0,007

0,257

0,290

(2)

Table 5: Correlation matrix for the key variables (n=262).

0,165

-,136

0,026

0,032

-,007

0,085

0,146

0,125

0,108

(3)

0,413

0,454

-,093

0,508

-,241

0,142

0,280

0,291

(4)

0,146

0,268

0,012

0,379

0,573

0,532

0,227

(5)

0,334

0,519

-,041

0,412

0,075

0,149

(6)

0,524

0,449

0,391

-,015

0,279

(7)

0,245

0,348

-,170

0,152

(8)

0,496

0,405

-,048

(9)

0,148

0,380

(10)

0,389

(11)

Discussion

29

Discussion

Table 6: Innovation orientation of Polish SMEs based on questionnaire responses from the SME sector (n=262). Mean

Ranking

Improvements to existing products or services

3,96

1

Quality management programs (ISO, TQM, Six Sigma)

3,87

2

Introduction of new products or services

3,71

3

Supply chain management (i.e., logistics, distribution)

3,69

4

Production improvement

3,60

5

Financial management

3,53

6

Co-operation systems with clients and suppliers, etc.

3,48

7

Accounting

3,47

8

Education and training of all employees

3,43

9

Business re-engineering or benchmarking

3,40

10

Acquisition of third-party intellectual property rights

3,39

11

Human resources

3,38

12

Team work

3,34

13

Marketing

3,29

14

Decision making

3,25

15

Information exchange

3,18

16

Decentralization

3,06

17

Internal Communications

2,98

18

Organizational structure

2,87

19

Use of advanced technologies

2,83

20

Notes: Own analysis based on questionnaire responses from the SME sector. The numbers in the first column reflect the arithmetic average of responses in each category based on a 5-point Likert scale. The second column indicates the importance of each variable.

Some “mismatches” were found between the needs of the Polish SME sector and external sources of financing. Firstly, in terms of providing capital, a significant misalignment exists between the actual financial needs of the SME sector and the available financing options (including those generated from government-support programs). Figure 3 shows the differences in the financing options available to the SME sector. Although there are two distinct capital expectation categories (one around $0.4 million and the other about $1.5 million), none of the programs address them (commercial banks are interested in providing larger loans and venture capitalists are outside of the range). On the other hand, government-sponsored initiatives offer either very small amounts of capital (around the $50,000 - $60,000 mark, or less than $5,000) or larger tranches (around $0.8 million). Both government tranches seem to miss the desired capital needs of the SME sector. Secondly, differences exist between the target firms of commercial banks and the demographic characteristics of the respondents. Based on the questionnaire, the banking sector prefers firms with sales of up to $8 million; the largest respondent category had sales of up to $2.0

Discussion

million. Pronounced differences are also found in the profit expectations of the two groups of respondents. Similar differences exist between the SME sector and the venture capital industry. Figure 3: Preferred capital targets for various capital providers, compared with the capital needs of the Polish SME sector. 4

Financing mismatch

$ Mln

3 2 1

SME needs

Government

Commercial

programs

banks

Venture capital

Notes: Own analysis based on questionnaire responses from the SME and banking sector, and desktop research on venture capital activity and government support programs. The left hand-side of the graph presents the two categories of financial need for the SME sector, while the middle side shows the financial programs offered by the government. The right side of the graph captures the level of financing supplied by commercial banks and venture capital firms. The lines in the graph highlight the most pronounced mismatches between capital needs and availability.

Figure 4 presents a perceptual map of the major financing programs available to the SME sector, as well as others from the public sector (i.e. universities, research institutes, research centers, laboratories, incubators and municipalities, etc.). The programs dedicated to the SME sector have a solid line to the ellipse while the programs dedicated at a wider audience (as described above) are linked with a dotted line. Three main conclusions can be drawn. Firstly, numerous programs are dedicated to micro and small firms (loans around $50,000 – $60,000). Limited loan facilities are dedicated to larger projects (e.g. Technology Loans), and many of these loans are classified as loans for a special purpose or activity (i.e. directed towards R&D, innovation, patent creation, or technology). Secondly, commercial banks seem to provide firms with one of two levels of capital. The first appears to be at around the $2 million mark and the second is at around $4 million. Thirdly, the averages desired by the venture capital and private equity sector are well above those outlined in the graph (in excess of $10 million). It is important to note, however, that a handful of venture capital firms are interested in smaller deals (e.g. MCI and CARESBAC). As outlined in the graph, two main areas reflect possible gaps. One is in the $0.6 – $1.5 million range and the other is in the $3 million range. Ideally, programs would be developed in such a manner that all empty spots on the perceptual map would be filled.

Liquidity gap

31

Discussion

Figure 4: The landscape of the major financing programs available to the SME sector. PRIVATE EQUITY COMMERCIAL BANKS

$4M

POSSIBLE GAP $3M COMMERCIAL BANKS $2M POSSIBLE GAP NVCF

$1M

IE TL

TS Capital ($M)

PF PE

P+

IV ML+MF+IM

Mikro



IC TS Małe

Średnie

Duże

Stage of firms development Innovation

R&D

Technology

Export

General

SME needs

Notes: Own analysis. Abbreviated names for programs are: IE – Innovative Economy; PE – Passport for Export; ML – Micro Lending; IV – Innovative Voucher; TL – Technology Loan; TS – Techno-start; P+ – Patent PLUS; IC – Innovation Creator; FB – First Business; NVCF – National Venture Capital Fund; MF – Micro Fund; and IM – Initiative Micro.

The analysis presented below relates to the determination of an “effective” liquidity gap. The assumption in this analysis is that the effective liquidity gap for the SME sector may be larger than as presented in Figure 4. Government-support programs may become unavailable to the SME sector for a variety of reasons. Firstly, some programs may have too many pre-requisites or qualifiers; firms in the SME sector may find them discriminatory. Many government programs request projects with specific investment needs (e.g. Internet technologies, intellectual property and laboratory equipment). If firms have different investment objectives, they are unlikely to benefit from such programs. For example, a firm that requires additional working capital (which is cited as one of the most desirable areas of additional financing) is unlikely to qualify for a program with the requirements identified above. Secondly, many programs are seasonal and applicants can only apply for them within specific time periods. If a firm’s actual needs do not match the timing anticipated by the programs, the potential applicant loses an opportunity to secure financial or nonfinancial assistance in a timely manner. This means that programs, initiatives, acquisitions, and other business activities could be postponed

Discussion

for a period of at least one year. Thirdly, the target audience for many government-support programs is very wide ranging; it includes other government institutions (national or local), universities, municipalities, and the private sector. The SME sector effectively competes for financial resources with different parts of the government, which effectively limits the available resources and crowds out the private sector. Figure 5 presents the framework of the map presented in Figure 6, but excluding all the programs (the excluded programs have been subjectively assessed and were seen to poorly serve the SME sector). The map exposes more empty spots and liquidity gaps within the different areas of financing available to the SME sector. Figure 5: Possible enlargement of the liquidity gaps for the SME sector. PRIVATE EQUITY COMMERCIAL BANKS

$4M

POSSIBLE GAP

$3M COMMERCIAL BANKS $2M

NVCF

$1M

Kapitał ($M)

FB PE

POSSIBLE GAP

ML+MF+IM

Micro



Small

Medium

Large

Wielość firmy / etap rozwoju Innovation

R&D

Technology

Export

Ogólne

Potrzeby MSP

Notes: Own analysis. Please note that further evidence exists of “cash hoarding” by commercial banks, resulting in a smaller market offer to the SME sector (hence, the reduced ellipse around the commercial banks). The analysis here is subjective as are the selected criteria for excluding certain programs from the perceptual map. The adoption of different criteria will result in a different perceptual map. Almost certainly, the application of any set of discriminating criteria is likely to expand the liquidity gaps rather than decrease them. The value of the analysis is that it demonstrates that the contemplated effectiveness of government support programs may be less than anticipated. In this specific example, government programs are removed if they meet two out of the three subjective criteria listed below: programs that are offered to other participants (public or private) in addition to financing SMEs; programs that only accept applications at certain times of the year, and programs with requirements that are too strict. Abbreviated names for programs: PE – Passport for Export; ML – Micro Lending; FB – First Business; NVCF – National Venture Capital Fund; MF – Micro Fund, and IM – Initiative Micro.

33

Discussion

Structure of government support programs in Poland Government Support Programmes

Five ministries (from a total of 17) and about 350 governmentsponsored public and private institutions and agencies are active in developing and offering programs aimed at supporting the SME sector. The Polish government operates about 16 major programs (see Table 7 for a summary of these programs). Most programs are relatively new (they commenced in 2007 or 2008) and as such it is difficult to evaluate whether or not they are correctly fulfilling their functions. Some of the programs have already undergone corrective measures and adjustments due to public complaints or lack of interest. Other programs that started in the mid-2000s (such as the National Venture Capital Fund) have made virtually no impact on the Polish SME sector. The vast majority of these programs are offered by the Ministry of Economy (managed by PAED) and the Ministry of Science and Higher Education. These programs can be broadly classified into six distinct activities: financial assistance, training and re-tooling assistance, advisory and consultancy services, marketing assistance, infrastructure provision, and research and development focus. These services are described below.

Skills training

Financial assistance programs were described in detail in previous sections. The available training assistance programs are directed towards two types of audience: business owners or young managers who need managerial training in key functional areas of their business, and skilled workers looking to improve their technical skills in areas of their expertise. For example, the Human Capital Program, developed by the Ministry of Regional Development and delivered by PAED, aims to increase the competitiveness of Polish industry by providing hands-on training and skill development. In addition, various components of programs such as the Innovative Economy and the Development of Eastern Poland include sections devoted to training. Additional training is provided by 190 national SME service centers (operating as local chambers of commerce, development agencies, business support programs and not-for-profit centers, etc.) and by the European Social Fund. Additional programs are offered by the Ministry of Science and Higher Education. These include training and support in the areas of innovation, intellectual property management, and start-up technology ventures. Some programs are offered in collaboration with European academic centers. Advisory services aim at providing management consultancy for firms. The key areas of assistance relate to raising financing, preparing business plans, improving products, introducing quality control mechanisms, implementing financial reporting systems, and introducing procedures for preparing budget and financial forecasts, etc. PAED offers firms from the SME sector

Discussion

a network of about 100 pre-qualified and registered agencies that offer free or paid-for-service advisory services aimed at new start-ups and larger firms. Under these programs, the firm is able to apply for financing to purchase advisory services. These services are offered through a “consultancy voucher,” or by applying for the coverage of the consultancy fee up to a specific amount (normally not exceeding $5,000, and in other cases, not exceeding 15% of the total value of the project). Such services are also available from the PHARE program. In addition to financing, marketing assistance represents one of the most neglected functions of business in the SME sector. Firms from the SME sector need assistance in identifying markets and market demand for their products or services (including collecting data on market size) and outlining key competitive dynamics and their competitive advantages. While none of the programs specifically deal with these issues, general programs focusing on SME competitiveness, innovation, or human capital development seem to offer some support in this area. Such programs are structured by PAED and are offered by its network of local partners. Access to the physical infrastructure and related amenities (telephone, fax, email and laboratories, etc) are among the key challenges for new and rapidly expanding businesses. These functions are traditionally filled by business incubators (described earlier), which provide the physical infrastructure and additional support services (accounting support, consultancy, business plan preparation and networking, etc). Two of PAED’s programs offer access to physical infrastructure as a part of their wider offer. Additional support in this area is provided by a wide range of business incubators and technology parks. Most of the programs are operated as public or public/private initiatives.

Other support methods

The level of research and development in firms is often regarded as one of the key determinants of their success. Innovation in the SME sector can occur at different levels. Many of the programs offered by PAED and other ministries seem to focus on this issue (they include Patent PLUS, Innovation Creator, and Startup IT). These programs are offered or co-sponsored by the Ministry of Science and Higher Education, and provide financial and technical support for innovation as well as for research and development. It is important to note, however, that these are new programs (most were established in 2007 or 2008). PAED also offers financial assistance targeted at innovation - up to $5,000 (through the Innovation Support Program) for younger firms, and up to $600,000 (Innovation Loan) for larger enterprises.

Research and development

35

Discussion

Table 7: Summary of the major programs to support the SME sector, which are offered by the Ministry of Economy, the Ministry of Regional Development, the Ministry of Science and Higher Education, and the National Trade Bank (Bank Gospodarstwa Krajowego).

Marketing assistance

Infrastructure provision

R&D focus

Advisory services

Training assistance

Financial assistance

Functions

x

x

x

x

x

x

x

x

x

MINISTRY OF ECONOMY Incubator Development Program

x

x

PARP Human Capital

x

Innovative Economy

x

Export Development

x

Development of Eastern Poland Micro Lending

x

Bank Guarantee Fund

x

Technology Loan

x

x

x

x

x

x

Techno-start

x

Ministry of Regional Development Innovative Economy

x

Human Capital

x

x

Development of Eastern Poland

x

x

Ministry of Science and Higher Education Patent PLUS

x

Human Capital

x x

Innovative Economy

x

Bank Guarantee Fund

x

Innovation Creator CambridgePYTHON x

Academic Entrepreneurship

x

Others Incubators

x x

x

Startup IT

x

x

x

x

x

x

x

x

x

x

x

x x

x

x

Discussion

Ministry of Labor and Social Policy Human Capital Innovative Economy

x x

Handicapped Support

x x

x

x

x

Ministry of State Treasury National Trade Bank (BGK)

x

Bank Guarantee (KFPK)

x

Technology Loan (FKT)

x

First Business (PB)

x

EU Pre-financing

x

Notes: Own analysis based on various Internet and printed materials from the Polish government.

Many of the programs have been duplicated across a number of different Polish ministries. Even though a large number of governmentsponsored programs exist, many of the programs offered by one ministry are duplicates of programs offered by another. For example, the Innovative Economy Program, initially developed and sponsored by the Ministry of Regional Development, is now offered by the Ministry of Economy and delivered through PAED. While the benefits of different ministries offering these programs may be obvious (in terms of expanding the number of distribution channels), developing different brochures and appointing the numerous individuals to monitor them is not cost effective. Duplication of programmes

Many programs in Poland are broadly-based – they try to appeal to different stakeholders in the Polish economy, such as entrepreneurs, employees, public institutions and agencies, research centers, business and technology incubators, universities, public/private institutions, and research and development institutes, etc. It is difficult to quantify the actual benefit they have on the SME sector. In addition, many programs are not offered on a continuous basis - applications are solicited only at predetermined times; usually once or twice per year. If an urgent project were to arise, the firm would have to wait for the next intake period to apply for support.

Structure of innovation initiatives The low usage rate of government-support programs (described in more detail in the following section) raises an interesting dilemma for government officials, in terms of how they structure support programs for the SME sector. One of the main concerns involves how to properly match the programs to the actual needs of SME firms (this was one of the key concerns raised in the follow-up discussions). Given the

37

Discussion

relatively low propensity for innovation among Polish SME firms, it must be determined whether or not a single program is likely to be effective in addressing the innovation agendas of the sector, or if different programs, aimed at the different needs of the SME sector, need to be established. Principal factor extraction with varimax rotation was employed to discern groupings of innovation initiatives undertaken by respondents. Using a factor loading of 0.50 as the cut-off for inclusion within a factor, innovation initiatives undertaken by firms from the SME sector were separated into three factors (eigen values>1). Consequently, these factors were interpreted as “innovation conceptualization” (explaining 25.4% of the variance), “innovation implementation” (explaining 17.5% of the variance), and “functional innovation” related to disseminating innovation throughout the organization (explaining 13.8% of the variance -- see Table 8). The twenty innovation initiatives used in the questionnaire provide a comprehensive innovation framework for the SME sector. The percentage variance explained by the three factors was 56.7%. Additionally, a Cronbach alpha was computed to indicate the reliability of the construct, with values ranging from 0.74 to 0.87. This generally confirms the effectiveness of the chosen innovation parameters in defining the innovation environment of the Polish SME sector. The existence of the three factors confirms that firms from the SME sector address issues related to innovation in accordance with themes or common considerations. These factors are also considered to be stages of innovation, as the factors capture the natural progression of firms through the innovation process. Innovation conceptualization

Factor 1, termed as innovation conceptualization, defines issues related to initial considerations of innovation in the firm. This activity normally represents the first step in the innovation process. The firms initially consider improvements to an existing product or service offer, which can improve their market position. Alternatively, firms purchase intellectual property; however, this can be expensive, especially for newly-established businesses that are likely to lack sufficient financial resources. This indicates that firms initially tend to avoid new product or service development. To improve an existing offer, a firm must consider the most appropriate method of delivering product or service enhancement – this can be accomplished through the use of advanced technologies (e.g., new production machinery and equipment) or by introducing quality management programs (which are popular among Polish firms). Innovation activities also require co-operation between departments and teamwork. Such activities also require financial planning and analysis; hence, the finance department must be involved early in the innovation process.

Discussion

Table 8: Factor loadings, reliability analysis for innovation concerns, and three factor groups (n=262).

Factor 3: functional innovation

Factor 2: innovation implementation

Factor 1: innovation conceptualization

Factor Loadings

Introduction of new products or services

0,65

Improvements to existing products/services

0,80

Acquisition of third-party intellectual property

0,87

Education and training of all employees

0,60

Business re-engineering or benchmarking

0,75

Production improvement

0,82

Quality management programs

0,64

Information exchange

0,78

Use of advanced technologies

0.92

Decision making

0,51

Co-operation systems

0,67

Organizational structure

0,78

Team work

0,54

Decentralization

0,76

Internal communication

0,72

Marketing

0,73

Supply chain management

0,64

Financial management

0,69

Human resources

0,61

Accounting Cronbach’s α∂

0,70 0,87

0,81

0,74

Percentage of variance explained

25,4%

17,5%

13,8%

Total percentage of variance explained

56,7%

Notes: Own analysis based on questionnaire from the SME sector. Cronbach’s α is a measure of construct reliability and consistency.

Factor 2, named innovation implementation, involves a focus on operational matters in converting innovation concepts into implementable solutions. As an example, innovation implementation for production firms is likely to focus on production initiatives. Any redesigns and the implementation of new internal processes are performed on the basis of internal evaluations such as benchmarking or re-engineering. There must also be additional training for employees to involve these employees in the firm. Relationships with the firm’s stakeholders (e.g. suppliers, clients) may also be revisited.

Innovation implementation

39

Discussion

Functional innovation

Finally, firms must dedicate their efforts to instilling innovation concepts throughout the entire business, through functional departments; this is captured by Factor 3. The primary activity here involves engaging the entire organization in the process of innovation, including supply chain management, accounting, and human resources. The consequences of instilling this innovation potentially include changes to the organizational structure and the internal links found within the firm. It is also important to note that only when the organizational functions are well coordinated can a firm be ready to implement new products or services and actively engage in internal R&D activities.

Accessibility of government support programs An integral part of the evaluation of existing government policy instruments is ascertaining the extent to which current government policy initiatives actually meet the demands of entrepreneurial firms in the SME sector. The key areas of investigation include evaluating the extent to which firms from the SME sector use government support programs, the reasons for using or not using these programs, and the needs of the SME sector with respect to specific assistance. Accessibility of programmes

The accessibility of the government-support programs is best captured in the actual usage of the program. In general, accessibility was found to be poor. The research study confirmed that only 6.5% of respondents (17 respondents) had any experience with government support programs. This result is consistent with earlier studies (Grabowski et al., 2003) and is surprisingly low for at least two reasons. Firstly, in the questionnaire the firms declared a great need for capital and know-how assistance. Secondly, the survey focused on the Warsaw region, where general knowledge and awareness of assistance programs was expected to be more widespread throughout the business community. In the study, small firms were found to be the largest users of government programs, accounting for almost 50% of the firms from the SME sector. The lowest usage was noted in micro firms.

Low usage

The low usage of the programs unquestionably stems from a limited awareness of them. Over 70% of all respondents from the survey indicated an inadequate awareness of the support programs. Only about 15% of respondents declared a satisfactory knowledge and awareness of these programs. Among the firms that actually participated in the program, 61% declared the need to obtain financing as their primary interest in the program, while 39% were interested in know-how assistance. In terms of advisory needs, 35% of respondents declared that they required assistance in obtaining bank financing. This further underscores the problem of access to capital for the SME sector. The

Discussion

second most important category related to business plan preparation. This is undoubtedly connected with the first point related to obtaining capital, as lacking a business plan almost entirely precludes a business from obtaining any type of financing. About 18% of respondents required additional consulting services. Informal discussions with the firms indicated that they required assistance in key functional areas of the business; most notably marketing and promotion, accounting and budgeting, and production. A profile of the 17 participants that declared use of the government programs is outlined in Table 9. The firms that chose public assistance were predominantly medium-size manufacturing businesses that had been in business for more than three years. These firms successfully increased their business at a rate of over 20% per annum, and the majority of them had sales of over $2.1 million. These businesses were also strongly profitable (the majority had net profits in excess of $0.9 million) and had high capital needs (between $1 and $4 million) directed towards fixed asset purchases (29.4%) and working capital (29.4%). Their level of investment dedicated to R&D expenditure was 23.4%. Table 9: Descriptive statistics and demographic data about the Polish SME sector participating in the government-sponsored programs (n=17). Firm’s demographics

%

Number of employees

Firm’s demographics

%

Firm’s years in operation

1-9

35,3

1–2

11,8

10 – 49

41,2

3–4

29,4

50 - 249

23,5

5–6

17,6

7–8

17,6

>8

23,5

Sector of operation

Financing needs

Production

52,9

Fixed assets

29,4

Construction

11,8

Intangible assets

Retail and wholesale

23,5

Working capital

29,4

Marketing and promotion

11,8

5,9

Hotels and restaurants

0,0

Transport

5,9 R&D

23,5

Telecommunications

0,0 Export activity

11,8

Financial services

0,0 Others

Health related

0,0

Other

5,9

0,0

Competitive Position Worsened significantly

5,9

Worsened slightly

11,8

Stayed the same

11,8

Improved slightly

52,9

Improved significantly

17,6

41

Discussion

Firm’s financial standing

%

Firm’s financial standing

Sales levels (mln $)

%

Net profit (mln $)

< 0,2

0,0

0 – 0,4

0,2 – 0,4

0,0

0,5 – 0,8

17,6

0,5 – 1,0

5,9

0,9 – 1,2

35,3

1,1 – 2,0

17,6

1,3 – 1,6

17,6

2,1 – 4,0

52,9

1,7 – 2,0

23,5

4,1 – 10,0

17,6

> 2,0

10,1 – 30,0

5,9

> 30,0

0,0

Capital needs (mln $)

0,0

5,9 0,0

Sales growth*

< 0,04

0,0

0 – 5%

0,0

0,04 – 0,2

0,0

6 – 10%

0,0

0,3 – 0,4

0,0

11 – 20%

29,4

0,5 – 1,0

5,9

21 – 30%

64,7

1,1 – 2,0

41,2

2,1 – 4,0

47,1

4,1 – 6,0

5,9

> 6,0

0,0

Firm’s innovation orientation*

%

New product Introductions 0

> 30%

Firm’s innovation orientation*

5,9

%

Revenue from new products 0,0

<1%

0,0

1–2

17,6

1 – 2%

23,5

3–4

29,4

3 – 4%

11,8

5–6

11,8

5 – 6%

29,4

7–8

23,5

>6%

35,3

>8

17,6

Expenditure on R&D (mln $) 0 0,04 – 0,08

Number of registered patents 0,0 0,0

0 1–5

0,0 0,0

0,09 – 0,2

41,2

6 – 10

29,4

0,3 – 0,4

23,5

11 – 20

64,7

0,5 – 0,6

23,5

21 – 30

5,9

> 0,6

11,8

>30

0,0

Notes: Own analysis based on questionnaire responses from the SME sector from respondents, who participated in the government-support programs. Note that variable groups with an asterisk relate to the firm’s orientation in the last three years. The remaining variable groups relate to data from the last year. The percentage in each category was calculated on the basis of the number of respondents in each category in relation to the total number of respondents.

Discussion

Respondents’ assessment of government-support programs Based on the research questionnaire, the quantitative assessment of the quality of the government-support programs varies from category to category (see Table 10). The most serious concerns raised by the respondents related to the quality of the technical assistance offered by external advisors and the bureaucratic nature of the governmentsupport programs.

In terms of the quality of assistance found in some of the most important areas, the highest rankings are attributed to the provision of services focused on research and access to information (average = 3.97) and co-operation with trading partners (3.80). This reflects the poor availability of market and competitive data in Poland. Firms, especially those in their early stages of development, often have difficulty establishing key parameters for the industries in which they participate. These parameters include market size (volume and value), market share, and the financial performance of existing market players. Consequently, the firms attribute high value to professional assistance in these areas. The next highest ranked category related to the quality of training services (3.75). This underscores the point that external advisors are effective in providing training to the SME sector and are wellprepared for such activity. Many of the government-accredited advisory centers employ academics who are skilled in setting learning objectives, preparing teaching materials, and training. Assistance with obtaining financing (3.08) was ranked as one of the lowest categories, along with the preparation of a business plan (2.79). The low scores in these two areas reflect the frustrations of respondents with obtaining external financing. Even well-prepared business plans do not see actual financing if capital suppliers are unwilling to extend credit to the sector.

Quality of assistance

In terms of other quality measures, firms from the SME sector were found to enjoy overall co-operation with external advisors. This is reflected in two categories: ease of communication with consultants (average = 3.45) and ease of co-operation with consultants (3.25). This indicates that external advisors and firms are able to establish effective working relationships. The technical qualities of the advisory services were ranked significantly lower, both in terms of sector expertise (2.62) and consultants’ business knowledge (2.89). This finding is of serious concern, because it underlines a considerable weakness in the government support programs in key areas of expertise. It is perhaps unrealistic to expect that every local governmentsponsored support center has sector specialists or specialists in specific business areas – advisors at these centers are generalists rather than specialists. On the other hand, firms should be able to obtain access to more specialized assistance even if such resources have to be brought in

High assessment of consultants

43

Discussion

from another region of the country. The lowest scores were attributed to the bureaucratic nature of the programs. The speed of approval of a firm’s application received the lowest score (2.42), along with the ease of preparing the documentation (2.47). The respondents also had significant problems with the ways key criteria were interpreted to award assistance. This was particularly true for projects that had been rejected by government agencies and where subsequent appeals had been made. Table 10: Descriptive statistics about the usage of governmentsupport programs by the Polish SME sector (n=17). Participation rates and program awareness

%

Participation in the program

Program usage and quality assessment

% or mean - raking

Areas of assistance

Yes

6,5

No

93,5

Obtaining capital

35,3

Advisory and consulting services

17,6

Training

Participation among SME

5,9

Business plan preparation

29,4

Co-operation with trading partners

5,9

Research and access to information

0,0

Other services

5,9

Quality of service in assistance areas

1-9

23,5

Obtaining capital

3,08 - 6

10 – 49

47,1

Advisory and consulting services

3,12 - 5

50 – 249

29,4

Training

3,75 - 4

Business plan preparation

2,79 - 3

Co-operation with trading partners

3,80 - 2

Research and access to information

3,97 - 1

Other services

3,06 - 7

Quality of service in other areas

Program awareness

Very adequate

4,6

Ease of access to information

2,60 - 6

Ease of communication with consultants

3,45 - 1 3,25 - 2

2,62 - 5

Somewhat adequate

10,7

Adequate

11,8

Somewhat inadequate

55,3

Ease of co-operation with consultants

Very inadequate

17,6

Sector expertise of consultants

Discussion

Key reason for participation Obtaining capital Obtaining know-how

Consultants’ general business knowledge

2,89 - 3

Speed of application approval

2,42 - 8

Ease of documentation preparation

2,47 - 7

Clarity of selection criteria (if any)

2,71 - 4

64,7 35,3

Notes: Own analysis based on questionnaire responses from the SME sector from respondents, who participated in the government-support programs. Note that variable groups with an asterisk relate to the firm’s orientation in the last three years. The remaining variable groups relate to data from the last year. The numbers in the last column reflect the arithmetic average of responses in each category based on a 5-point Likert scale from the respondents’ pool (n=17). The second column indicates the ranking of each variable within a specific category. The percentage in some categories was calculated on the basis of the number of respondents in a specific category in relation to the total number of respondents.

Six of the seventeen respondents agreed to follow-up discussions. It is important to note that none of the respondents in this pool ever requested assistance again from the government after their initial experiences. The discussions can be summarized in five main themes. Firstly, the respondents were critical of the bureaucratic nature of the programs and cited this as the key reason for not pursuing additional assistance. This was done in spite of the fact that they were experiencing normal business-operating challenges (e.g. staff acquisition and retention, market assessment, developing international business connections, competing with Western business rivals, and financial needs, etc.). The respondents found the application process cumbersome. Applicants needed to develop a comprehensive package that included their application, numerous documents, certificates, confirmations, and financial statements, etc. Most respondents indicated that the government programs were more demanding of information and written material than banks were when granting loans. The respondents also complained about applications being returned to them as “incomplete” due to insignificant mistakes, errors, or omissions being found in the application form. Most agreed that the costs and the time commitment required to prepare the necessary documents ultimately outweighed the intended benefits of the program. Secondly, the respondents felt that the offered programs did not reflect their actual needs. The respondents indicated that their firms had developed relatively quickly in terms of sales and had outgrown the programs offered by the government. They suggested that the programs need to be tailored to stages of business development rather than focused on government-preferred themes (e.g. computerization).

Respondents’ opinions

45

Discussion

The respondents also complained about the lack of highly-specialized advisors in key business areas (for example, working capital management, acquisitions, and crisis management). In other words, the respondents confirmed that the government programs are not well tuned to their firms’ business environment and actual needs. Thirdly, the respondents had varying experiences with respect to the quality of the service offered to them. While some respondents continued their relationships with their external advisors or consultants beyond their initial assignment, many more used the programs only because they were offered on a preferential cost basis – they were unwilling to pay for such services on a full cost basis. The lack of practical experience of the external advisors in certain sectors was cited as a key concern. Fourthly, the respondents indicated that the external advisors preferred to be involved in discrete tasks rather than in overall business development. Other concerns raised related to co-payment or co-investment requirements, the limited availability of information on the programs, and the fragmented nature of many programs (e.g. too many programs made it difficult to find an available appropriate program that fitted a firm’s needs).

Conclusions For firms in many countries, pursuing technological innovation is a viable alternative. In Poland, technological change and innovation is more than an alternative – it is an imperative. Not only is technological innovation important for the prosperity of individual private firms, it is also one of the fundamental contributors to the country’s economic growth. Poland’s economic growth and prosperity depends on how effective local firms are in marketing new technologies and innovations and converting private firms from the SME sector into viable business ventures with a sustainable competitive advantage. In recent years, the role of science and technology in fostering economic growth has received increased attention from economists and policymakers. Technological change and innovation is widely recognized as a key driver of economic development.

Innovation as a must

The study posed three main hypotheses. The available data and subsequent analysis, while largely subjective, appears to provide strong evidence of the existence of liquidity gaps in the financing found within the Polish SME sector. The analysis for the remaining two hypotheses is based on weaker empirical evidence. The evidence provided for the analysis of the two hypotheses is based on a small number of respondents (n=17) and provides a limited basis for making policy recommendations to the Polish government. With respect to the first research hypothesis, there is strong evidence to confirm the existence of liquidity gaps in the market place. The presence of market imperfections became especially pronounced when some government programs, which were effectively not providing assistance to the SME sector, were removed. It is important to emphasize that the Polish government had the right idea by dividing their focus into two areas: small firms and larger firms., While the conceptual framework appeared in order, evidence has, however, revealed that government policies were imprecisely targeting government programs towards the SME sector, especially in the higher end of financial needs. The actual needs of the SME sector may differ from what is currently addressed by the offered programs.

Hypothesis I

The second research hypothesis related to the structure of government assistance programs for the SME sector. The research found that government support programs are poorly structured to help the sector. This is for many reasons. Firstly, the programs are fragmented - there are five ministries, about 350 government institutions, and about 40 programs, which are aimed at supporting firms from the sector. The implication is that the programs are spread out too widely and that

Hypothesis II

47

Conclusions

none of them has the SME sector as its sole focus. There are also problems related to the duplication of costs, additional oversight, and monitoring. Secondly, many SME programs are contained within larger structural programs – these programs are untargeted and offer potential benefits to wide audiences, including municipalities, universities and agencies, etc. Moreover, many of the points raised above reflect poorly on the structure of SME programming. Hypothesis III

The third hypothesis relates to the accessibility of government programs by firms in the SME sector. Current government support programs do not appear to meet the actual needs of the SME sector. The use of these programs was found to be poor – only 6.5% of respondents actually used the programs. This was especially surprising given the geographic focus of the research (i.e., the Warsaw region) and the close proximity of the firms to the programs. The respondents also indicated a low awareness of the programs and rated their quality as low. Assistance in obtaining capital was found to be a key concern for the SME sector, further underscoring the problem of access to finance for firms. Other conclusions can be reached from the study. Firstly, the study confirms that the SME sector does not face a single typical challenge with respect to its approach to innovation. Factor analysis, based on the entire sample (n=262), reveals that the SME sector must contend with different themes or problems that relate to innovation conceptualization, innovation implementation and functional innovation. No single government-support program is likely to be effective in supporting the innovation activities of the SME sector. Secondly and most importantly, data confirms that Polish SME firms generally struggle with marketing. They are unable to translate their commitment to R&D into strong market offers to consumers.

Recommendations The overall objective of the research study was to provide the Polish government with general directions for the development of policy recommendations with respect to its role as an active participant in the development of the SME sector in Poland. The aim of the recommendations was to focus on the main themes and concepts rather than to provide detailed steps, program descriptions, costs and budgets – these can be developed once the main recommendations are accepted, as two or three alternative routes of activity are evaluated in detail and specific programs and budgets have been developed around these alternatives. These ideas could become the basis for follow-up studies and internal discussions. Five recommendations focused on developing the SME sector are offered below: Increase access to capital for SMEs. The lack of access to capital is consistently cited as the major obstacle to the development of the SME sector in Poland. Most activities of the sector focus on this area, most advisory services provided to the sector deal with this area, and most informal discussions center on this concern. The need for increased access to capital is also evidenced by the existence of the liquidity gap. An investment program equal to $4.9 billion is recommended to support the development of the SME sector in Poland (see Appendix A for further analysis). The focus should be on the two most pronounced gaps - the range of $0.3 to $2.0 million and the $3.5 million level. The primary objective of the program is to support the development of the SME sector and allow the effective transitioning of firms from one stage of development to another. This will ultimately lead to increased innovation, as the propensity to innovate among firms from the Polish SME sector increases in line with the size of the business.

Access to capital

Increase awareness of government support programs for SMEs. The current financial commitment to various programs, which is in excess of $26 billion, is met with low awareness from the business community. A quarterly advertising program in the national and local media is suggested as the first step in increasing the SME sector’s awareness of these programs – this should continue for at least two years. These efforts could also be supplemented by video podcasts, Internet programs, or other technologies, and by making presentations at organized business events or conferences to advertise the programs throughout the country. Firms from the SME sector should develop their relationship with government support programs early in their development. Firms should also be offered ample information (e.g. brochures and publications) during their business registration or establishment.

Increase awareness

49

Recommendations

Simplification of procedures

Simplify and tune-up government support programs. An increase in the awareness of the programs available to the SME sector should be accompanied by an overall simplification of the programs offered. Academic research and informal discussions with firms from the SME sector confirm that the process of obtaining any type of assistance is long and driven by bureaucracy. The approval process could be broken down into a number of steps to ensure a quick decision for the applicant. A one-page description of the business and its needs – or a pre-qualification document - could be examined and dealt with by the government in days, rather than months. Hands-on assistance to applicants could then be provided on demand. The overall aim should be to limit the approval process to three or four weeks. The key concern of poor access to specialized assistance could be overcome by creating a national registry of advisors, where qualified consultants from different regions are available to serve other regions. Government support programs could also focus on a firm’s stage of development or on one of the major problem themes experienced by the SME sector as outlined in this paper.

Institutional concentration

Create a separate ministry or agency that focuses solely on SMEs. Currently, the role of assisting firms from the SME sector is spread across many ministries, agencies, and educational institutions. This paper calls for the development of a central government unit that focuses on the SME sector. This could be achieved in a number of ways. Firstly, the government could establish a new ministry that is focused solely on the development of the SME sector. Alternatively, the Ministry of Regional Development could be reformed to focus on SMEs (many of the original programs for SMEs were developed by this ministry). Secondly, if these efforts are not feasible or are costly, a separate agency could be formed. PAED could be restructured to focus solely on the SME sector, or another agency could be established. Additionally, the programs should be consolidated to limit their numbers. New programming could then be offered in conjunction with local universities and educational institutions (students then get the opportunity to participate in the programs).

Synergy

Combine capital and know-how as a package. Many of the programs offered by the government should be combined in a capital and knowhow package. Obtaining capital would be conditional on receiving hands-on assistance. This ensures the effective use of capital, and increases a firm’s success rate. Additionally, external advisors should offer more continuous assistance to the SME sector, rather than focusing on discrete tasks or efforts. Their involvement should be based on achieving mutually agreed business milestones. They should also be involved in project implementation, as opposed to simply providing

Recommendations

advice. For example, consultants should go beyond simple consultations to extend their involvement in projects to completing specific tasks (obtaining financing rather than preparing business plans; establishing and signing new business deals, rather than establishing contacts, and designing and producing new packaging, rather than providing advice on “how to”, etc). The assistance programs should be developed around “mentorship initiatives” rather than on the achievement of discrete, one-off goals.

51

Endnotes 1 The analysis of available resources proves that data for 2007-2008 is aggregated in such a way that it would be impossible to formulate similar tabulations. 2 All sums are given in USD to ease comparative studies. 3 Based on information available from PAED.

Appendix A: The size of a potential government financing to support the development of the Polish SME sector. Sector of Economy Micro # of firms per sector

Small

Medium

Large

1 652 998

44 228

14 708

2 981

% distribution of firms in economy

96,39

2,58

0,86

0,17

Firm migration patterns:

1 652 998

44 228

14 708

2 981

Year 1

2 000

150

20

Year 2

2 000

150

20

Year 3

2 000

150

20

Year 4

2 000

150

20

Year 5

2 000

150

20

Failure rates per sector

5

2

1

2 211

294

30

1 642 998

51 267

15 064

3 051

95,95%

2,99%

0,88%

0,18%

2

22

105

860

3 453 554

1 131 847

1 584 945

2 623 062

-21 020

+155 396

+37 316

+60 341

Anticipated # of firm failures Adjusted # of firms in sectors New structure of firms in economy Number of employees per firm Total employment per sector Net increases (decreases) in employment Net increase in employment = 232 033 Capital required per project per sector ($)

330 000

1 600 000

4 000 000

Size of government program ($ million)

3 300

1 200

400

330

120

40

2 970

1 080

360 50%

VC ($ million) Bank lending ($ million) Leverage potential of equity

50%

50%

Further potential to raise debt

165 000

60 000

+7 813

+2 841

+947

163 209

40 157

61 288

Incremental employment from leverage Adjusted employment creation Net increase in employment = 243 635

53

Key assumptions are as follows: - The total size of the government support program is equal to $4.9 billion over 5 years; - Firms migrate from micro to small, from small to medium, and from medium to large; - Firms are financeable and are able to meet basic criteria in terms of liquidity and profitability; - SME migration is based on historical patterns; - 10% of projects are financed through equity – this reflects a slight improvement in percentage of firms financed by private equity in a normal commercial environment (venture capital finances less than 5% of deals); - Venture capital financing allows for additional leverage for firms; at 50% leverage firms are able to raise additional 50% of debt financing. Additional average is likely to translate into additional employment; - About 2,160 firms are influenced by the program, which is equal to 0.13% of all firms in Poland; - Capital requirements are set at two levels: $0.3 million (from micro to small firms) and $1.6 million (from small to medium). This is consistent with research findings; - The program creates 243,635 new jobs; - The “Adjusted employment creation” also includes a loss of 21,020 jobs in the micro sector.

List of tables and figures Table 1:

The SME sector - aggregate and average statistics from Poland....9

Figure 1: Key statistics (fundraising, investing, and exiting) for the Polish venture capital industry between 1990 and 2007........... 17 Figure 2: The average deal size in venture capital investing in Poland as well as the percentage of total capital dedicated to seed and start-up as well as expansion firms for the venture capital industry between 1999 and 2007........................................... 18 Table 2: Descriptive statistics and demographic data concerning the Polish commercial banking sector’s lending preferences and loan recipients in the Warsaw region (n=24)........................... 20 Table 3: Summary of the financial characteristics of the major government-sponsored programs............................................ 23 Table 4: Descriptive statistics and demographic data concerning the Polish SME sector in the Warsaw region (n=262)..................... 25 Table 5:

Correlation matrix for the key variables (n=262)..................... 29

Table 6: Innovation orientation of Polish SMEs based on questionnaire responses from the SME sector (n=262)................................. 30 Figure 3: Preferred capital targets for various capital providers, compared with the capital needs of the Polish SME sector.......... 31 Figure 4: The landscape of the major financing programs available to the SME sector................................................................... 32 Figure 5:

Possible enlargement of the liquidity gaps for the SME sector. . . 33

Table 7: Summary of the major programs to support the SME sector, which are offered by the Ministry of Economy, the Ministry of Regional Development, the Ministry of Science and Higher Education, and the National Trade Bank (Bank Gospodarstwa Krajowego).......................................................................... .36 Table 8: Factor loadings, reliability analysis for innovation concerns, and three factor groups (n=262)........................................... 39 Table 9: Descriptive statistics and demographic data about the Polish SME sector participating in the government-sponsored programs (n=17).................................................................. 41 Table 10: Descriptive statistics about the usage of government-support programs by the Polish SME sector (n=17)............................. 44

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Notes

Author Darek Klonowski Dr Darek Klonowski is a Full Professor of Business Administration at Brandon University, Canada. He has worked in the venture capital industry for over almost years, making investments throughout Central and Eastern Europe (CEE), most notably at Enterprise Investors and Copernicus Capital Management (now Abris Capital Partners). Dr. Klonowski also advised multiple clients on asset allocation strategies in the CEE region. He has participated in numerous industry conferences as guest speaker and discussion panel member. He has written extensively on entrepreneurship and venture capital in the CEE region. [[email protected]]

Rondo ONZ 1 00-124 Warsaw tel. +48 (22) 557 70 00 fax +48 (22) 557 70 01 www.bettergovernment.pl