The Big Impact of Small Business

Full Transcript

Note: This transcript was generated by an automated system and has been lightly edited for clarity. It may contain errors or omissions.

Uriel Castillo: One-eighty. Fourteen dollar even.

Kevin Cool: In a city parking lot in Richmond, California on a recent Friday morning, three food sellers take different approaches to charging customers at the weekly farmer’s market.

One of them, Steve Lee from New American Farms, won’t accept credit cards.

Steve Lee: Uh, yeah, cash only over here.

Producer: Oh, okay.

Kevin Cool: But it doesn’t stop people from asking anyway.

Steve Lee: They try to go to like find the nearest ATM to come, like, get stuff, you know, cause, they want their greens, you know?

Kevin Cool: It’s been that way for the 20 plus years Steve’s family has been showing up at markets like this with produce from their farm in rural Fresno County, 185 miles away. And there’s no plan to add the systems required to take cards or other electronic payments.

Steve Lee: For, like, my dad, like, he’s not really used to, like, using it and whatnot, so it’s, it’s gonna be, like, a huge hassle, just, like, going through, like, the whole systems and whatnot. Cause like, I could do Apple Pay too, but then it’s not going straight to the business, you know?

Kevin Cool: At the other end of the market, Uriel Castillo from Stockton is swiping cards on the white box prominently displayed at his farm stand. A line snakes around the tables.

Uriel Castillo: 5.35. Yeah, we do this for the last three years.

Producer: Yeah.

Uriel Castillo: We never before used this system before. But now I know that we got some business right there. This another 25, 40%, Yeah. Yeah.

Kevin Cool: That’s 25-40% more business after he began taking credit cards 3 years ago.

Uriel Castillo: For me, cash is a lot better, because you know, less taxes to pay, but business is business, we can do everything.

Kevin Cool: In between Steve and Uriel is a local mushroom farmer named Kevin Perdomo. Customers are paying in cash and there’s no credit card machine visible.

Kevin Perdomo: It’s kind of like a popular market scenario, right? When you go around the world and you visit these popular markets like everything is in cash.

Kevin Cool: But Kevin won’t say no if a customer asks.

Kevin Perdomo: People ask me, Hey, do you take card? Yes, I take card. And then now they know. But generally, people also understand that there are credit card processing fees, debit card processing fees, so when they can, they’ll pay in cash. It’s a bit of a dance, right?

Kevin Cool: Kevin says the technology is available enough that any of the farmers could take cards if they wanted to.

Kevin Perdomo: I have a smartphone, right? And if I have a smartphone, and I’m in the United States, I can download an app and take those payments. It does take a bit longer than cash. And it does cost us more. But, uh, it’s possible.

Kevin Cool: This tension between how customers want to pay and what farmers are willing to accept plays out at the fruit and vegetable stands throughout the weekly market.

Kevin Perdomo: We’re all here, the farmers come, we bring the produce to the people. And then they try to meet us halfway as well and keep the money flowing, the produce flowing, people are being fed, we’re all getting paid hopefully, and everything is well.

Kevin Cool: Small businesses like these are a frontier in the study of market dynamics, especially in developing countries, according to Stanford Graduate School of Business marketing professor Sridhar Narayanan.

Sridhar Narayanan: The puzzle that we had was with easy access to lots of resources for modernizing themselves, why are many businesses and so many of them still look and feel and operate in traditional ways? The answer to that question has a lot of bearing for everything from public policy to large businesses that operate through these small businesses.

Kevin Cool: And that’s our focus today: what the challenges facing small businesses around the world can teach us about the global economy.

Kevin Cool: This is If/Then, a podcast from Stanford Graduate School of Business, where we examine research findings that can help us navigate the complex issues facing us in business, leadership, and society.I’m Kevin Cool, Senior Editor at Stanford GSB.

Kevin Cool: Small businesses in developing countries play sort of an outsized role in those economies. Can you talk a little bit about that?

Sridhar Narayanan: Yeah, small businesses worldwide, actually, not just in developing countries, are really engine of employment, of growth. In developing countries, that role is even greater.

Sridhar Narayanan: It’s not just that they employ people and provide critical services at the last mile to consumers in these countries, but they also facilitate large businesses to operate there. For instance, if you look at my own company that I worked for, Unilever, it couldn’t reach its products to its customers without relying on hundreds of thousands of small retailers all over India alone and all over the world.

Kevin Cool: So just as a quick example, Unilever has a wide range of products, but something like say shampoo, it’s hard to sell shampoo unless you have retailers on the ground with that product in lots of places.

Sridhar Narayanan: Absolutely. And small businesses play more than just the role of reaching products to consumers in developing countries. They play a critical role in extending credit. So, for instance, if you look at India as an example, or Africa, a large proportion of the population depends on agriculture for a living. And agriculture is a profession where you get cash flows at certain times of year, at harvest.

Sridhar Narayanan: And so, a lot of families in these countries, buy things on credit and pay the businesses when they get cash. Beyond agriculture, a lot of the retail sector in developing countries is fueled by credit. To customers who don’t have other sources of credit, they’re not in the formal banking system often, they don’t have a credit history, they cannot access formal means of credit. The retailers who operate at the local level, small mom and pop businesses are not just retailers for them, but they’re also their neighbors. They know their creditworthiness and therefore they are able to extend that credit down to the last customer.

They also serve as a critical source of reference. So for new products, particularly where consumers may not be familiar with them, retailers serve as a source of credible information to them.

Kevin Cool: So let’s talk about the study that you did with retailers in Mexico City. First of all, why Mexico City? And what were you trying to learn?

Sridhar Narayanan: it’s a vast city with a large population and a large number of small businesses that cater to customers.Mexico City has a wide diversity of businesses. So it has large format retail, just like you would find in any developed country, and it has customers who are quite wealthy, and at the same time, it has a large population of people who are lower down in the economic strata and also are served by mom and pop retail businesses close to where they live. So Mexico City is a large city, lots of mom and pop businesses, a lot of them quite traditional in how they operate in their backroom operations all the way to their storefront.

Sridhar Narayanan: What I mean by that is that there are small businesses that don’t have a lot of automation. They don’t necessarily have even a computer or a checkout for keeping track of purchases to issue receipts and so on. They have a selection of products that they stock, but no formal systems of keeping track of what they have.

Sridhar Narayanan: They’re often operating on cash. Sometimes they’re extending credit, like I mentioned earlier.

So that’s the kind of scale of businesses. The puzzle that we had was with access to easy access relatively to lots of resources for modernizing themselves. Why are many businesses and so many of them still look and feel and operate in traditional ways?

Sridhar Narayanan: And there’s obviously, two ways to think about it. One is that they choose to be that way because that signals accessibility, low prices for customers at the bottom of the pyramid, or that they are constrained in terms of resources and access to know how to modernize themselves and the answer to that question has a lot of bearing for everything from public policy.

Sridhar Narayanan: Governments are trying to modernize and formalize their economies more to large businesses that operate through these small businesses and thinking about how they can make them more effective.

Kevin Cool: So when you’re talking about modernizing the businesses, what specifically do you mean by that? What sort of tactics or things that you wanted to experiment with in your study?

Sridhar Narayanan: Aspects of a retail business that are visible to customers, the store appearance, whether there are clear signages for things like prices of products or not, are things organized on the shelf or not, is there branding from the store or not, how is the interaction between the salesperson and their customers, things like that, kind of a broad bucket of brand management.

Sridhar Narayanan: A second aspect of it was things that are not visible to customers but operate at the back end. Product management, things like how do they keep track of their sales? Do they know which products make the most margins or not? How do they decide their product assortment to stock? Do they have modern ways of dealing with inventory and ordering systems and so on?And so we were asking, first of all, what prevents businesses, which are small mom and pop stores, from adapting some of these practices? And second, if they do adopt them, is it worth it for them? Does it pay off an investment in either of these?

Kevin Cool: You worked with 1100 retailers. What were the results? What did you discover?

Sridhar Narayanan: The bottom line is that modernization really improved their revenues for both groups who were modernized on the brand management side as well as on the product management side, both of them saw anywhere ranging between 15 and 25 percent increase in revenues.

We went back after 18 months to again collect data on the revenues and profits and so on. And it was sticky. So kind of bottom line is that there was an increase in revenues. Second, the investments were paid off in six months of increased profits, so it really took not that much investment and it paid itself off relatively quickly.

And I was telling you that the initial motivation of this study was this puzzle that businesses choose to be traditional because it signals that they are accessible, that the prices are low, et cetera. If they modernize, the thought is that their customers might think that they are going to be more expensive, they’re not for us, they won’t have the products we are interested in because they’re used to seeing richer consumers shop at large supermarkets. What we found is that that’s not true, it’s basically constraints in resources and know how that were preventing many of these businesses from being modernized.

Kevin Cool: Those revenue gains are pretty compelling especially if, as you say, they’re sticky and last long term.

So you mentioned that there were some small businesses that like to remain traditional. Is there resistance to modernization, even if the results in these other cases were compelling?

Sridhar Narayanan: The resistance, if any, comes from fear of getting in the crosshairs of government, of tax authorities, you know, it’s not just taxes and a lot of the developing world small businesses have to deal with corruption at the level of government authorities.

Sridhar Narayanan: And so if you somehow get modernized and you look like you’re a business that’s doing well. You could be target of not just tax authorities coming and looking into your books to see whether you’re making more money than you’re reporting, things like that, but also be the target of extortion from local officials.

Kevin Cool: So being under the radar would be considered a positive thing.

Sridhar Narayanan: Yeah. So in India, for instance, when I was working at Unilever, our distributors were typically in a local market in a small town, for instance, the most wealthy, also the best business experience kind of people. And they would tend to want to stay under the radar, not because they wanted to necessarily avoid taxes, but they wanted to avoid hassles.

Sridhar Narayanan: And so governments have tried to make things more efficient, more automated to eliminate the opportunities for corruption. That’s not gone away by any means, but I think that’s less of a concern for many businesses than it was a few decades ago.

Kevin Cool: You have a paper now that’s awaiting publication that talks about another aspect of modernization, which is the extent to which financial technology plays a role in these businesses. What did you learn about the challenges for adopting different payment systems in developing countries?

Sridhar Narayanan: So the background for this is that in the developing world in particular, much of the economy is run on cash. And if you look at the retail sector, people pay for goods on cash, even if they have a debit card, our context was in Guadalajara, one of the other large cities in Mexico, a larger proportion than many other developing countries actually of the population has access to debit cards, for instance, they might get payroll, they might get paid on a debit card, but they go withdraw cash from the debit card and go to businesses to pay with cash.

Sridhar Narayanan: And that was a puzzle. We found that a large number of businesses did not accept any other form of payment other than cash. And we also knew through our partners in the government that this was despite the fact that the government had spent millions of dollars actually on promoting non-cash means of payment, mobile payment, credit card based payment, and so on.

Sridhar Narayanan: Governments, of course, have an interest in doing that because it formalizes more of the economy, becomes trackable…

Kevin Cool: Sure, from the government’s perspective, presumably there’s a lot of opacity in a cash economy.

Sridhar Narayanan: Exactly. And also it’s a source of what is called black money, you know, money which is unaccounted for, taxes are not paid for it and so on.

Sridhar Narayanan: So they basically dropped at a number of businesses, everything from a smartphone to a dongle to a data plan for a period of time for free. And yet, when we were in the field, we encountered some of these businesses that had got $1,000 worth of stuff for moving from a cash base to a non-cash transaction, and they’d never conducted a non-cash transaction ever. They didn’t even know where that technology was.

And so that kind of raised a puzzle in our minds as to why are businesses not transacting in anything other than cash? And there are three things that came to our mind. One was that they might have technological constraints. They might not know how to use it. They might not have a bank account linked to it. They might not have the basic things needed to facilitate non-cash transactions. Even if they have a device, a dongle, a data plan, and all of that, you need some additional things to make it functional. A second thing it might be that their customers might not be asking for it. They might not even know that they accept anything other than cash. And the third thing might be that when you use non-cash transactions, there’s other parties involved for processing payments, there’s technology companies, there’s a payment processor, and they need to be paid, and for that, most non-cash transactions involve a little bit of a commission, anywhere from three to five percent of the price, and that has to be passed on to the consumer, or the business has to eat those costs.

Sridhar Narayanan: Actually, one paper in a series of projects, we basically explore the barriers to adoption. And in subsequent projects, we’re going to explore once they adopt electronic transactions. What does it do to their revenues? Does it actually grow? What does it do to their profits?

Kevin Cool: Are mobile payments pretty widespread more generally in developing countries? It seems like even in very poor countries, a lot of people have cell phones, for example.

Sridhar Narayanan: Yes, smartphone penetration is very high. It’s one of the technologies that has very, very rapidly diffused all over the world, including in very, very poor countries and poor populations in those countries. If you look at countries like Kenya, for instance, I don’t know the latest statistic, but at one point, 60 percent of the transactions in the economy happen through mobile payment.

Sridhar Narayanan: India very rapidly moved from a largely cash based economy towards a large proportion of transactions moving to mobile payments. There’s been very rapid growth of mobile payments in the last decade or so. And then you see countries in Latin America, which are often still more cash-based. Even though the technologies are there, people have cell phones and mobile phones.

Kevin Cool: I wonder if there’s something cultural.

Sridhar Narayanan: There could be a variety of factors. There’s economic factors, there’s cultural factors, the history of the economies in Latin America might have something to do with it, with memories of hyperinflation and where when you get money, the instinct is to spend that cash right away because you don’t know what it’ll be worth tomorrow

Sridhar Narayanan: There’s also different levels of trust in institutions that varies across countries, often again, driven by history and what people have experienced in the past.

But also, public policy has a big role to play. One of the big reasons India modernized its payment systems very rapidly was public policy by the government or sometimes by non-government institutions.

Sridhar Narayanan: In Kenya, for instance, M-Pesa was the global payment solution that basically changed payments in that country. It was a private initiative and it rapidly grew in a country where other forms of payment were quite primitive. It started with people figuring out how to transfer money to their families.

Sridhar Narayanan: They were working in the city and their families were back in the village. And the traditional way was if you didn’t have access to financial institutions, like the people in the village might not have a bank account, you would either have to travel yourself or give it to a trusted person or sometimes even things like bus drivers would serve as a way of transporting money.

Sridhar Narayanan: But it was not an efficient way. It was not secure or safe and was prone to delays, all of those things. And so Kenya was a country where mobile payments took off first. And then it evolved from there. And this was pre smartphones, it was purely SMS-based.

Kevin Cool: So there were a few different variables that you were studying. Can you just talk about what you learned?

Sridhar Narayanan: We look at two things, two barriers to adoption of payment technologies. One was the technology itself, familiarity with the technology, how to use the app, have it set up, which we call technological barriers, broadly.

Sridhar Narayanan: And the second one was around information, so for their customers to know that they accept payment methods other than cash. Firstly, they can access credit to pay for things. Secondly, they have a record of the transaction, often in cases where otherwise they might not. Third, they have some purchase protection.

Sridhar Narayanan: If they buy something through a mobile payment, they are protected if they get a fake product or something that doesn’t work, whereas if they pay cash, they have no recourse. Broadly, what we found was that both of these barriers are important, and they are, by the way, sequential. You need to first solve the technological barriers for the informational barriers to even be relevant, right? If there’s no operating technology, there’s no point of making consumers aware of the benefits of payments.

Kevin Cool: Yeah.

Sridhar Narayanan: And what we found was that a big proportion of the barrier was actually basic technological barriers. They didn’t know how to operate the app or they hadn’t linked it to a bank account.

Sridhar Narayanan: And solving these is inexpensive, relatively, we had people help them set it up, come back to kind of check if things were working right and solve these micro issues, onboarding challenges typically. And it turns out that a lot of the challenges are very, very specific to a particular business, and they differ widely across businesses.

Sridhar Narayanan: Also, there are two sides to this market, right? Businesses need to want to use non-cash based methods of payment, but their customers also need to want to do it.

You can’t solve this problem by looking at only one of these. More businesses will adopt it, more customers want to use other forms of payment, and more customers will adopt when they see lots of businesses where they can use it.

Kevin Cool: If we could somehow mobilize and execute on a widespread program to modernize small businesses like the ones you’re talking about, how profound would the effects of that be on the macroeconomy of a particular country and even more broadly globally?

Sridhar Narayanan: Modernizing small businesses will have a profound impact on economies worldwide in many ways.

Sridhar Narayanan: Firstly, just in these businesses, there’s a lot of efficiency to be gained. There’s a lot of loss overall. Just as a simple example in our Mexico City study, one of the key things of modernization was to reduce wastage. A lot of the businesses order goods more than they want, more than they need. They keep them on the shelves for a long period of time.

Sridhar Narayanan: Some of these things which have expiry dates expire and that’s a waste for the economy. If they had systems to track their sales and align their ordering systems with their sales, that could lead to a lot of reduction of waste and increase of efficiencies more generally.

Sridhar Narayanan: Second, if you look at small businesses, they have a huge impact on employment in a lot of these countries. And, you know, we’re facing huge challenges in the future through various ways. As the economies modernize as a whole, there’s been an entry of a large number of big businesses. And that’s led to a lot of fear around what will it do to employment? Because every time you replace a number of mom-and-pop stores with a large retail chain, you don’t have a one to one replacement in terms of employment.

Sridhar Narayanan: Overall, for the economies that’s in many ways a good thing, but at least in the medium term, it would leave a large number of customers underserved. Like I mentioned, a big role played by small businesses is that they extend credit to their customers, who would not have other sources of credit. And if these businesses were to go away, they might not be able to access goods the same way as they otherwise do.

Sridhar Narayanan: And I think it has very large implications for macroeconomic development of these economies as a whole and the global economy, because more than half the world lives in countries that are quite poor and are developing and small businesses are an engine of growth for them. So, learning about that is really important for a big part of the world.

Kevin Cool: If/Then is a podcast from Stanford Graduate School of Business. I’m your host, Kevin Cool. Our show is written and produced by Making Room and the content and design team at the GSB.

Our managing producers are Michael McDowell and Elizabeth Wyleczuk-Stern. Executive producers are Sorel Husbands Denholtz and Jim Colgan. Sound design and additional production support from Mumble Media and Aech Ashe.

And a special thanks to Steve Lee, Uriel Castillo, and Kevin Perdomo at the Richmond Farmer’s Market.

For more on our faculty and their research, find Stanford GSB online at gsb.stanford.edu or on social media @stanfordgsb.

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Steve Lee: They try to go to like find the nearest ATM to come, like, get stuff, you know, cause, they want their greens, you know?