“They look at us and they see risk.” Promoting SMEs in public procurement
SMEs have the flexibility and capacity required to develop ground-breaking approaches and solutions. Despite this, they are regularly underrepresented in public procurement, often as a result of misguided approaches to risk. We look at what Mexico and Korea have done to change this.
Governments often consider SMEs and startups as risky. SME solutions may not be well known to governments or may lack a proven track record. Their solutions may also require some additional time to mature and reach their full potential, or may need to be adapted to fit public sector business models. Yet, missing out on the dynamism of the SME sector can result in unharnessed creative potential and exclude many of the local entrepreneurs most familiar with your city’s challenges.
This is why governments around the world are developing risk management strategies to ensure SMEs can play an integral role in procurement. Opening up procurement to smaller and diverse providers promotes innovation, increases competition, brings down costs, and promotes local job creation.
“They look at us and they see risk”
Joel Mahoney, Co-Founder, Open Counter
Mexico: Ensuring SME Access to Credit
SMEs often lack access to credit. This is partly because they are smaller, have less collateral, and their credit worthiness is harder to assess than that of their larger counterparts. Access to credit, however, is essential for activities such as the modernization of facilities, technological development projects, and environmental improvements.
Firstly, NAFIN is helping SMEs use government contracts as collateral for loans. Engaging in government contracts can pose significant risk for SMEs: government entities do not pay for products and services in advance, and payments are often subject to delays. This means the burden of working capital is placed on the supplier. Suppliers, in other words, must be able to finance and deliver before receiving payment. Without large capital reserves, this makes it almost impossible for SMEs to become government suppliers.
NAFIN has developed reverse factoring services which allow SMEs to use their government contracts and accounts receivable as collateral to receive working capital financing. This means the creditworthiness of the buyer can be used to finance the working capital of the supplier. This program has helped broker more than 1.2 million transactions and extend over USD 9 billion in financing since 2001.
Secondly, NAFIN has launched the National Credit Guarantee Scheme in collaboration with the Secretary of Economy. This program substitutes some of the need for collateral with government guarantees; the government effectively guarantees loans which are defaulted on by loan-holders. The project has been highly successful in improving SME access to loans, most notably by reducing the amount of collateral required for loans and lowering interest rates.
What is particularly innovative about this program is that guarantees are publicly auctioned to financial institutions and commercial banks. This helps finance the scheme, spread risk, and improve loan conditions. The Credit Guarantee Scheme has benefitted 330,000 companies by guaranteeing USD 8,308 million in loans between 2005 and 2012.
Korea: The New Technology Purchasing Assurance Scheme
In Korea, SMEs account for 99.9% of total firms and about 87% of total employment. These are fundamental to the country’s economic resilience. During “the process of overcoming the financial crisis from late 1998 to 2004, the number of employees working for large enterprises decreased by 900,000 due to business restructuring, while SMEs created approximately 275,000 new jobs.”
Before 2005, SMEs accounted for less than 3% of total procurement expenditure. To bridge this gap, the Korean Small and Medium Business Administration (SMBA) updated the New Technology Purchasing Assurance Scheme in 2005 to improve SME participation in procurement. This helped leverage the benefits of SME engagement while mitigating risk, increasing SME participation in procurement to 9.3% of the total budget in 2009.
The update to the New Technology Purchasing Assurance Scheme introduced two measures to improve SME participation in public procurement: a Performance Certification System and a Performance Insurance System.
Firstly, a Performance Certification System for technology products was developed to guarantee quality. This provided potential buyers with the reassurance that previously unknown or not widely tested products would deliver according to expectations. Performance Certifications are issued by the Technology Product Procurement Promotion Committee. This body is made up of the SMBA administrator along with no more than 20 specialists, including directors of related ministries and the Korean Federation of SMEs.
Secondly, all products awarded this certification are subject to the Performance Insurance System. This insures the potential losses buyers may incur due to the procurement of these certified products. This could include insuring for underperformance, untimely breakdown, or delays in delivery. Reducing the burden of responsibility of the procurer can help ease risk aversion.
These measures were accompanied by government-initiated programs which offered marketing opportunities to SMEs, such as the promotion of newly developed products, as well as offering the Technological Product Purchase Target System to public institutions. The latter is a set of binding targets for SME-developed products within public procurement, with minimum targets set at 5% by 2006, rising to 10% by 2010.
The measures were highly successful in promoting SME engagement. In 2009, the overall amount awarded to SME contracts was KRW 2078.5 billion, or 9.3% of the overall expenditure.
Between 2007 and 2009, public organizations launched a total of 150 projects with SME products through the updated New Technology Purchasing Assurance, of which 139 were successful. A total of 32 public organizations took advantage of the scheme, including the governments of Daejon and Samcheok, and urban utilities as the Seoul Metro and Seoul Metropolitan Rapid Transit Corporation.
An additional benefit of these measures is that procurers have greater trust in the products and companies, and so can focus more closely on identifying solutions which best fit the needs to be addressed.
Takeaways
Engaging SMEs in public procurement can help deliver better solutions and stimulate local economic development. It makes flexible and innovative solutions available to government, while supporting small scale entrepreneurs with opportunities. Measures can range from providing easier access to credit, certification to help access new markets, and hedging financial risk.
