The Rise of SME - Technologies Helping SMEs to Compete and Save
After many years of development, the consumer technology space has been saturated and it’s rare to find consumer-facing startups that have the same potential as what Facebook or TikTok had in their early stages. Most large opportunities in the mobility, B2C logistics, and B2C e-commerce industry have already been captured. The relatively low market-entry barrier and high scalability nature of B2C businesses always attracts the best talent and most funding in very early stages.
On the other hand, enterprise B2B technologies have also been well developed in many markets because it is very attractive to entrepreneurs due to the nature of large business customers. Large enterprises typically have a higher willingness and ability to pay and the market is reasonably concentrated.
When it comes to small-to-medium enterprises (SMEs), the situation is very different. There are four reasons that the SME market is less attractive to entrepreneurs:
- Compared to selling directly to consumers, selling to SMEs has a relatively long sales cycle, resulting in a lower user growth rate - lower scalability in terms of the customer base.
- Compared to large enterprises, SMEs usually have a lower purchasing power and lower stability, which means a higher churn rate.
- Compared to large enterprises, SMEs are highly fragmented, meaning a lower ROI on startups’ marketing budget and lower scalability in terms of revenue.
- Compared to startups targeting large enterprises, companies selling to SMEs can hardly build a high market barrier by dominating a large share of the market, resulting in a high level of competition at a later stage once the business model has been validated.
Therefore, the nature and dynamics of the SME market make this group of customers less attractive to entrepreneurs and leaves this huge market underserved. However, a huge underserved market means a huge potential opportunity. In many countries, SMEs are a major contributor to the local economy. For example, with 34% of its GDP coming from informal businesses, Latin America and the Caribbean is the region with the most active informal economy in the world. For some other regions like Sub-Saharan Africa and South Asia, SMEs also contribute more than 30% of the local GDP.
A research paper from the Wharton School presents 4 major challenges that Latin America SMEs are facing: (1) technology that falls behind; (2) underdeveloped human capital; (3) an obstacle known as ‘marketing’; and (4) restrictions on loans.
Technology that Falls Behind: SMEs invest comparatively little in technology. And when they do, they often acquire equipment, machinery, and software that is inappropriate. Why? “Because, in order to modernize yourself, the first thing you have to do is to focus on the core of the business and only later think about technology,” notes Juan Carlos López, an executive at Neoris, a multinational consulting firm.
Underdeveloped Human Capital: In most small Latin American companies, the dominant way to get hired is through personal recommendations, notes Andrés Escobar, an economist at the University of Andes and specialist in public administration. Juan Carlos Echeverry, professor at the University of the Andes, agrees. “Small and medium-sized companies often lack career planning programs because they don’t have appropriate hiring practices that identify job candidates’ skills, weaknesses, aptitudes, and knowledge.”
Lack of Marketing: Experts agree that SMEs know how to produce goods but they often don’t know how to sell them. “They have a hard time adopting a marketing strategy in which the focus of the business is the customer; in which markets are segmented, new business opportunities become more visible, and a company moves into new areas,” says Ángela Enríquez, a marketing expert and dean of the Sergio Arboleda University, based in Bogotá.
Restrictions on Loans: Loans are a scarce resource for SMEs for a variety of reasons: their informal or underground nature; the administrative disorder that characterizes some SMEs; their lack of leadership; the absence of real loan guarantees; and a shortage of business information about small companies.
To sum up, when both the B2C and the large enterprise B2B markets have become saturated, many entrepreneurs start to pursue the colossal opportunities in the underserved SME market by fulfilling the unmet demand from SMEs.
GDP contribution from SMEs in different markets (Source:IMF)
A large portion of SMEs is focusing on emerging markets that are highly fragmented and underserved. Emerging markets today are the world’s main drivers of global growth and wealth accumulation. They cover a dominant share of the world’s population and natural resources. Emerging market countries represent 59% of the total global GDP, which is a significant expansion over the past years; in 2006 these countries represented less than half of global GDP.
Developed and emerging market share of global GDP (Source:Ashmore)
Companies in the SME technology space
Investment opportunities in SME Technology
SMEs in the major markets
Given the nature of SME markets, investors care most about the potential market size - where the SME technology startups can have the highest scalability. Based on the data from the World Bank, there are 28 markets that have more than one million micro/small/medium-sized enterprises (MSMEs).
Beyond the number of SMEs, investors would also like to consider the availability of technologies tailored to SMEs. For example, the US market is fairly developed with many technology solutions tailored to SMEs, and this means there are limited new opportunities for entrepreneurs. However, for markets such as Indonesia, Nigeria, Brazil, Mexico, Bangladesh, Pakistan, Egypt, Thailand, Kenya, Colombia, and Peru, the local technology markets are still in their early stage, and most of the existing startups are focusing on consumers. The SME market has been left far behind.
Key metrics for evaluating investment opportunities
When it comes to evaluating investment opportunities, the market size is one of the key factors similarly to B2C and large enterprise B2B markets. Because the SME market is typically very fragmented, a startup would only acquire a small percentage of the market at best. Therefore, a massive market is a MUST for investors to consider an investment.
For example, for startups providing fintech, supply chain and logistics, and e-commerce solutions to SMEs, the following metrics may be a good starting point to narrow down the opportunities when sourcing and evaluating startups.
- $ of TPV (Total Payment Volume)
- # of end customers (consumers)
- # of restaurants, hotels, clinics, mom-and-pop grocery shops, brick and mortar retail stores, etc.
- # of grocery/e-commerce/D2C retail deliveries
- $ of ticket size
- # and size of incumbent players in the respective market
- $ of resident income and spending
- National currency volatility
- Political and infrastructure stability
Business models for SME technology startups
SME technology startups will usually use the following business models:
- SaaS-based subscription fee
- % of the transaction volume as a transaction fee
- Commissions from sellers and/or buyers for marketplaces
- Interest revenue from customer deposit
- Revenue share with SMEs
- Profit/Cost-savings share with SMEs
- Platform model (e.g., Facebook, Twitter) - offering free products/services to end users while monetizing users through other channels ( e.g., advertising, marketing, data analytics)
However, investors may have different preferences for business models. Different business models mean different growth potentials. For example, given that the SME market is highly fragmented and that SMEs have a low willingness to pay, using a SaaS-based subscription fee model will indicate a limited potential of the business.
Different business models mean different growth speeds. For example, charging a SaaS-based monthly subscription fee will mean an upfront cost for SMEs, making it difficult to sell the product. While sharing the extra revenue/profit from using the startup’s product with SMEs will sound more acceptable to SMEs and make it easier to acquire those customers.
Success factors for SME technology startups
The success factors for SME technology startups are similar to those for other startups. For early-stage investment opportunities, the team comes right after the market size. Since the problems faced by SMEs are very different from the challenges faced by large enterprises or consumers, the right founding team should have deep knowledge about the SMEs’ pain points in the targeting industry and solid experience in communicating with the SMEs.
Specifically, since most of the technology solutions for SMEs are not new deep technologies but applications tailored for SMEs, experience in user growth in the SME space will be very important.
- Team with solid experience in the relevant industry
- Team with an understanding of the respective market dynamics
- Team with strong business development experience working with SMEs
- Team with strong product development experience
- Team with quick go-to-market capabilities
- Validated and clear product value proposition and high product scalability
- The product that is easy to deploy
- The business model that is sensible for the market and potential customer persona
- Low customer acquisition cost
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