Using consulting to improve managerial capital for SMEs

The growth challenges that small and medium-sized enterprises (SMEs) in developing markets struggle to overcome also limit their contributions to local and global economies. Most efforts to improve their growth have been financial interventions such as cash grants. On the other hand, improving the savviness and skills of owners to help them manage people and their business ('managerial capital' for short) through government-subsidised consulting or other means, may be a promising way to improve management, confidence, and performance, both in the short and long term.

Managerial capital and growth

Compare SMEs in developing regions to their counterparts in more developed economies, and it is apparent that developing-economy SMEs struggle to grow. Most attempts to understand why, and how to boost growth, have focused on finance (see Karlan et al. 2015 for a review of cash-grant experiments, for example). We have argued that managerial capital can also drive SME growth (Bruhn et al. 2010). This type of knowhow may help business leaders understand how to deploy capital optimally. Those leaders would be able to make better strategic and operational decisions, and improve the productivity of physical capital and labour.

Subsidised consulting for Mexico's SMEs

Our recent work has provided evidence for how a consulting intervention can improve managerial capital in SMEs based in Mexico. This has driven many business performance benefits, including longer-term ones. Specifically, we tested whether using management consulting to improve managerial capital had a first-order effect on the SMEs in our sample across a range of outcomes. We were also interested in which dimensions of managerial capital were most associated with performance.

We used a randomised controlled trial with a sample of 432 micro, small, and medium-sized enterprises in Puebla, Mexico, representing the manufacturing, commerce, and services sectors. We randomly assigned 150 of the firms to receive subsidised, managerial-capital-focused consulting (80 eventually took up the consulting services). The other 282 did not receive subsidised consulting, and served as a control group. Nine local consulting firms provided services to the treatment group. Over a one-year period, consultants met with business leaders for four hours each week. The consultants diagnosed opportunities for growth, and delivered customised recommendations on strategy, marketing, HR, and other areas.

We measured the consulting intervention’s impact using two surveys, one at the study’s start and one at a one-year follow-up point. This generated self-reported data on enterprise characteristics, business performance, and management confidence and skill. To offset any potential self-reporting biases associated with the surveys, we also used seven years (two years before our study, five years after) of Mexican Social Security Institute (IMSS) administrative data on employment levels and total wages for the firms. This provided information on long-term outcomes.

One challenge of our study design was that we were testing two closely associated hypotheses: first, whether managerial capital limits SME growth; and second, whether a consulting intervention improves managerial capital and, as a result, business performance. Even if we had found no significant effect of consulting, managerial capital deficits may still have been important limitations on growth, but the intervention had not been sufficient to eliminate them. Null results should thus have been viewed with caution.

Short- and long-term performance

The consulting intervention positively affected productivity, ROA, and profits at one-year follow-up for the firms in our study, with larger increases for productivity and ROA (about one-fifth of a standard deviation versus the control group) than for profits (about one-tenth of a standard deviation). Changes in sales, assets, and number of employees were not statistically significant. This was likely to be due to differences in the focus of consulting and intervention across firms. Improved managerial knowledge may have led some firms to increase capacity by hiring additional workers, for example, while others may have improved efficiency through personnel reductions.

Longer term, the government payroll tax data showed that the number of employees in firms that received consulting increased by 57% during the five years after the intervention. The total wage bill in treated firms rose by 72% during that period. The size of these effects is plausible, given that the majority of firms in our sample had few employees. These findings highlight the long-term impact of the consulting, and suggest that the positive survey results were not all due to self-reporting bias.

Improved management and entrepreneurial spirit

We also analysed which management areas and practices improved in response to consulting. We studied 11 areas – including finance, marketing, and operations – but only two were consistently mentioned by business owners and showed significant differences between pre- and post-intervention measures: their marketing, and their ability to keep formal accounts. Case studies suggested that long-term planning and business mission definition improved as well. This pattern of results suggests that different SMEs have different management needs.

There was significant improvement in 'entrepreneurial spirit' of owners and managers. We created an index to measure this, based on answers to questions about their confidence in their management capability, including areas such as growing the firm and addressing challenges. Respondents showed the most consistent improvement in how they set professional goals for their firms. Interviews with the consultants underscored this improvement in goal-setting.

Only 53% of the SMEs assigned randomly to the treatment group used the consulting services offered to them, despite our finding that the services could have had have high returns for firms in this category. The data suggests the businesses that refused the offer had funding constraints, or were uncertain about the benefits of consulting.

Limitations of the research

There was a high level of heterogeneity in the knowledge gaps of the SMEs in our sample. That is, it is possible that many mechanisms explain the improvements that we found. It is difficult to assess which are more likely at work in our study, and more generally in interventions designed to improve SME managerial capital and business outcomes (see Fischer and Karlan 2015 for more discussion of this). Additional analysis reinforces the idea that there is no silver bullet that will improve managerial capital and performance for SMEs.

While we found that improvements in managerial capital have had a large impact on SME performance, we did not examine specifically how the intervention interacted with the marginal productivity of inputs such as labour and capital. Similarly, our sample was not large enough to study potentially relevant factors such as the competitive landscape, owner age and gender, and other owner or manager characteristics such as ambition, risk-aversion, and general skills. Future studies in this area could examine these and other more granular issues. They could also investigate the broader issue of whether consulting and other interventions drive real macroeconomic benefits, or simply increase the market share of some firms, and number of people they employ, without

The case for improving managerial capital

Our study established that a lack of managerial capital can affect emerging-market SME practices and performance in a number of dimensions. It also suggests that improving managerial capital – in this case, through a consulting intervention – can have short- and long-term effects on firm performance and growth. These effects include better productivity, higher return on assets, improved entrepreneurial spirit of owners and managers, and more intermediate-term hiring.

But many SMEs are still reluctant to take advantage of consulting, partly because they are short of funds and uncertainty it will help them. We need to understand this better. Simply put, if consulting is so successful, why aren’t more firms hiring consultants? Perhaps heterogeneous returns to consulting explain low participation, or low information, or low trust, or low access to capital.

While we could not assess the returns to specific management interventions, we could provide an important proof of concept that efforts to improve managerial capital are worth pursuing through government subsidies and other incentive programs. We hope that further work can disentangle specific management practices, understand whether improvements lead to more macroeconomic growth rather than helping some firms at the cost of others, and understand the constraints to growth for the consulting industry itself.

References

Bruhn, M, D Karlan, and A Schoar (2010), “What Capital is Missing in Developing Countries?” American Economic Review: Papers & Proceedings 100: 629–633.

Fischer, G, and D Karlan (2015), “The Catch-22 of External Validity in the Context of Constraints to Firm Growth”, American Economic Review 105(5): 295–99.

Karlan, D, R Knight, and C Udry (2015), “Consulting and Capital Experiments with Microenterprise Tailors in Ghana”, Journal of Economic Behavior & Organization, Economic Experiments in Developing Countries 118: 281–302.