WHILE SA needs to promote small business, it is questionable whether setting aside some of the state procurement budget for small firms is the best way to do so.
The government would do better to focus on getting the National Treasury’s new e-procurement portal, which went live in April, up and running and on ensuring that enough small businesses have access to it.
In his state of the nation address in February, President Jacob Zuma said 30% of certain state procurement would be set aside for small businesses. There are signs that the government will not stop there. Deputy Trade and Industry Minister Mzwandile Masina said last month that the objective was to "institutionalise a 70% procurement target for emerging businesses".
The National Treasury has been engaging with the Department of Small Business Development to iron out technical details, ahead of drafting a practice note on the set-aside, which is expected by September.
In use elsewhere
A number of countries already set aside a certain percentage of state procurement for small businesses (including the US, Brazil and South Korea).
India became the latest to do so in April, with a policy that obligates state-owned enterprises and central government departments to source 20% of goods and services from small enterprises.
This will dramatically boost small companies there; a 2010 task team set up by then prime minister Manmohan Singh estimated that small businesses accounted for just 4% to 5% of the central government’s procurement spending.
But earmarking a certain percentage of procurement for small businesses risks introducing market distortions and can raise the cost of purchasing.
It's why the National Treasury (and the Chilean government too) has never been in favour of set-asides and why it issued a practice note in 2006 saying the practice was unconstitutional.
It later blocked a move by the Department of Trade and Industry to get the state to buy 85% of 10 specified goods and services from small businesses, because of concern that this was not in keeping with section 217(1) of the Constitution.
The section reads "when an organ of state in the national, provincial or local sphere of government, or any other institution identified in national legislation, contracts for goods or services, it must do so in accordance with a system which is fair, equitable, transparent, competitive and cost-effective".
In a procurement review published in February, the Treasury hinted it was prepared to reconsider set-asides, but only under certain circumstances.
These included that cost premiums were minimised and the measure was constitutional. It also insisted that a code of conduct be drafted to ensure sustainability, efficiency, cost-effectiveness and competent delivery. It remains to be seen how this will help the Treasury to navigate challenges such as pricing — where big companies have the economy of scale to undercut small firms.
To get around this, India’s set-aside in effect subsidises small firms that do business with the government. If a big company outbids a small rival on price, the policy allows small firms to match the big company’s price if it is no more than 15% higher.
India also has a priority purchasing programme, with 358 items reserved for purchase by the state from the small business sector.
In Brazil, a 2006 law granting set-asides allows small suppliers a 10% cost premium. It gives the sector priority on all purchases below 80,000 reals (about R300,000).
Last year 72% of these state contracts went to small businesses. Since the law took effect in 2008, small and micro-enterprises have seen their share of state procurement grow from 23% to touch 30% in 2013.
It may be difficult to get around allowing a price difference, particularly as SA’s economy is dominated by large players.
Taxpayers may be able to stomach the set-aside if the Treasury can prove that in allowing small firms to charge a premium, these firms are able to create jobs faster than if price differences were not allowed.
There is another potential problem: small firms could simply act as fronts for large firms or misrepresent their turnover to benefit from the set-aside. In the US, rules ensure that small businesses cannot subcontract out more than half of contracts in sectors other than construction.
Transgressors face fines of $500,000. Companies that misstate their size can be blacklisted from doing work with the federal government.
There are few if any studies to show how effective small business set-asides have been, even though a 2013 study revealed that set-asides employed by major US cities in the 1970s helped to lower the gap between the percentage of black and white Americans who were self-employed, by more than a third.
Take it online
A strategy that may arguably be more effective — and will not risk distorting the market — is to move procurement online.
In South Korea, the share of contracts that went to small and micro-enterprises through the country’s e-procurement portal increased from 55% of the value of all contracts in 2003, a year after the portal was launched, to 75% in 2010, a 2012 report shows.
Similarly Chile’s e-procurement portal, Chile Compra, increased the share of contracts (by value) that went to small and micro-enterprises to 44% in the first half of 2013 from 24% after the portal’s first year in 2003, according to a report published last year by the agency.
The key in Chile is that the portal is available through 16 regional centres, where businesses are also able to get support in using the site, as well as mentoring on tendering, while supply chain officials in the government ran regional buyer meetings.
There, despite apprehension, the digital divide did not prove a barrier to small firms, and today 91% of the 116,000 suppliers to the portal are small and micro businesses.
This year will mark the beginning of the first phase of the government’s national broadband rollout. Should this go well, it will bode well for the adoption of e-procurement bids by small firms.
Train public servants
No doubt Chile’s focus on creating a professional corps that specialises in procurement has also helped.
Chile Compra runs regular distance-learning courses for buyers to prepare them to undergo a test through which they can gain accreditation as competent state buyers. About 14,000 officials have been accredited.
The National Treasury's procurement review notes that officials who are responsible for state procurement are often inexperienced and that there is a high turnover of supply-chain officials. SA must therefore focus on training officials too.
Set-asides are ultimately a serious risk. By corralling a certain portion of the market, they amount to protectionist measures that can end up costing taxpayers more than they are worth.
An electronic portal that will make it easier and more affordable for small firms to participate in state procurement is a safer bet. But to ensure the portal is accessible to all, the government must do more to make internet access affordable.
This article originally appeared last week in Business Day. Click here to read the original.
Stephen Timm is a