Is trust a crucial factor for small businesses in Africa to succeed?

Victoria has been running a small business that deals in computers and medical equipment in Dar es Salaam for about five years now. While she is making a bit of money, the business has in fact not grown to a point where she can afford an extra hand.

Compared to trends in industrial and emerging economies, small businesses like Victoria’s operating in developing countries have generally failed to become the main vectors of growth, job creation, and innovation. This failure is generally attributed to insufficient skills and financial resources in the hands of local entrepreneurs in addition to unreasonable administrative and transport costs.

Valid as these arguments might be, they also miss a crucial factor which might be instrumental in the apparent flourishing of such firms elsewhere: trust, or the lack thereof, of small firms in their operating environment.

Distrust – or lack of trust – works against the success of small businesses in many ways. It is depicted in the standard payment policy of 100% upfront in order to guard against the risk of not being paid after the merchandise is delivered. Such a policy is detrimental as small firms lose clients who do not always have the resources at hand given their restricted cash flow. Indeed, in the US where less than 20% of transactions are on a cash basis, a firm would risk losing many of its customers if it was to adopt such a policy today

Lack of trust affects all facets of business

A small business like Victoria’s also suffers from its own employees. Because of the distrust – lack of trust – small businesses, when they can afford it, will only recruit workers they ‘trust’ and these are generally from the inner family circle or the same ethnic group. As a matter of fact, only 10% of operating firms in Tanzania have hired workers outside of their households. But family members or tribe’s people may not always be the most competent for the job and this has a negative impact on innovation and, therefore, the growth of enterprise.

Distrust is also present in their efforts to access credit, which is vital for their expansion. With no access to credit, firms are forced to postpone crucial investment and other decisions. For those who have the capacity to provide credit (i.e. the informal ‘loan sharks’ as they are called), they often end up raising the stakes to ridiculous limits in terms of interest rates and general conditions as they do not trust the borrower to pay back. On the other hand, the small businessperson – Victoria – has this inherent fear of borrowing because she feels the terms and conditions are often designed to ensure she forfeits whatever asset she borrows against.

Distrust in the general environment is exacerbated by the common occurrence of armed robberies and other attacks including the lacing of food and drink which can threaten normal business operations depending on how much reassurance you can provide the clientele (by, for instance, investing in security around your premises if you are running a restaurant). If Dar es Salaam is not yet Nairobi or Lagos, the level of insecurity has increased considerably in recent years. The insecurity is not exclusively an urban phenomenon in Tanzania as it is now a major concern in rural areas. In 2010/11, more than 80,000 heads of cattle and half a million shoats were stolen.

Business is fraught with risks; small business especially so. And while bigger businesses will be able to protect themselves from some of the risks, such as theft, through insurance and other measures including purchasing security systems or sophisticated software, by their nature, smaller businesses in the developing world are simply unable to do so as they lack the time and money.

Transforming small firms as vector of growth and employment will require a set of measures that will aim at restoring trust in their enabling environment.

Jacques Morisset is a World Bank Lead Economist based in Dar es Salaam, responsible for Tanzania, Uganda and Burundi.