This article draws on a recent International Trade Centre publication by the authors titled "SME Competitiveness Outlook 2022: Connected Services, Competitive Businesses”
Services play a crucial role in contemporary economies. The share of least developed countries (LDCs) in which the services sector was the main engine of economic growth more than doubled from 38% in 1995 to 77% in 2019. Globally, services generated about two thirds of economic output in 2019 and created most jobs. Small and medium-sized enterprises (SMEs) in a few key sectors are at the heart of this services-led economic transformation.
Most services enterprises are small, with nine out of ten of them having fewer than 100 employees. Entry costs are generally lower than in other sectors. Compared with manufacturing, it is easier to be small and export in services. Where small services firms are competitive and export, they contribute to development and economic transformation.
Some services are more important
Yet not all service sectors are created equal. Some of them are at the heart of the trends driving contemporary economic change. During the industrial revolution, the textiles and clothing industry led economic transformation. It was built upon new ways of organizing production, such as the apparel assembly line, and new technologies, such as the cotton gin.
In more recent times, the way of organizing production is the international supply chain, and technologies are digital. A set of four services, which the International Trade Centre (ITC) calls ‘connected services’, are at the centre of these contemporary economic trends. They are transport and logistics, financial services, information and communication technologies, and business and professional services.
These four connected services are critical to supply chains, in which services now provide a greater share of value – a process known as ‘servicification.’ They are also frontrunners in using digital technologies, which enable services once viewed as local to be offered across borders. They provide the ingredients all firms need to prosper – efficient payment solutions and innovative financing, reliable digital and physical connectivity, and cutting-edge business expertise.
Connected services are valuable in their own right, contributing directly to economic growth. Employment is increasing rapidly in these sectors, particularly in low-income countries, where growth averaged 8% annually in 2007-2019, compared with 4% in manufacturing and 2% in agriculture. In LDCs, export growth of connected services outpaced that of other services between 2007 and 2019, and was faster than in the rest of the world. These sectors attract more investment from abroad. And they reinvest a larger share of their revenue in innovation.
Connected services make all firms competitive
However, it is their contribution to overall competitiveness that makes connected services critical. This indirect effect works by providing key inputs to other firms in the economy. ITC research shows that firms in all sectors are more competitive when they have access to high-quality connected services. In regions with high-quality connected services, 44% of all companies export, compared with 19% of firms where such services are weaker.
This is because good quality connected service inputs lead to good business practices that foster export competitiveness. Analysis of ITC SME Competitiveness Survey data shows, for example, that 78% of firms with access to high-quality logistics services have good inventory management – compared with 36% of those depending on low-quality services.
In addition, 46% of companies with access to high-quality financial services often create new products or processes, compared with 31% of companies depending on low-quality services. And 58% of companies with access to high-quality ICT services have a website, compared with 35% that depend on low-quality services.
Export-ready small services firms
Despite the importance of service inputs to export competitiveness, most small firms in developing countries do not access these services easily, or at a high quality. For example, nine out of 10 large firms hired professional logistics companies to bring inputs from suppliers and ship output to buyers, compared with six out of 10 SMEs. SMEs often lack the amount or goods needed to fill a transport container or engage an independent logistics firm. When they handle the logistics on their own, however, they may have to wrangle with truckers and navigate convoluted customs forms.
Even when SMEs outsourced connected services, the quality tended to be unsatisfactory. Among large firms that outsourced, 53% scored the quality of those services as good. In contrast, 34% of SMEs were satisfied. There is in this context a need to improve the supply of globally competitive connected services. Local providers are necessary in some of these services, such as business and professional services and logistics.
Importing connected services from SMEs in neighbouring countries can also help businesses at home to become more competitive. Generally, services firms are less likely to export than those in manufacturing. This is partly because trade costs are on average higher in services than in manufacturing. Still, it seems easier for small services firms to export than for small manufacturing businesses.
The export gap between small and large firms is twice as large in manufacturing than in services. Specifically, small and medium-sized enterprises are 49 percentage points less likely to export than large firms in the manufacturing sector. In services, though, they are only 22 percentage points less likely to export than large firms.
Domestic services firms perform worse than services exporters in just a few features of competitiveness: connecting to buyers and institutions, certification and innovation. As a result, domestic services firms need to improve fewer aspects of their business operations to start exporting than those in manufacturing.
Most of the value in contemporary trade comes from the provision of connected services at the beginning and end of value chains. A few emerging economies account for most exports of connected services, and a few large corporations dominate key parts of these industries. However, there are many opportunities for SMEs in the provision of these services. Connected service providers within developing countries are succeeding as they customize and adapt offerings for local needs.
ITC research identifies four competencies that are often lacking, but critical to the competitiveness of connected services SMEs. These are the ability to grow networks, innovate, deepen skills and use finance to diversify products and markets. The Connected Services, Competitive Businesses Plan showcased in ITC’s SME Competitiveness Outlook 2022 summarizes key actions along these fronts. It sets out how companies can address the identified shortcomings, and how business support institutions and governments can play a critical role in ensuring that all companies have access to these important inputs.
Connected services make our societies more equal by spurring inclusive growth favourable to small businesses, including those led by women and young people. The gap in trade participation, while still present, is smaller for women-led and youth-led services firms than manufacturing ones.
As LDCs currently face multiple crises, a services-led approach to development can help countries leapfrog and transform their economies. It is time to step up our efforts to help small firms both provide and access connected services. By working with actors at enterprise, business support ecosystem and government levels, we can weave a tapestry of support to take small businesses online and into the global trading system.