Broad-Based Development in The Kingdom of Saudi Arabia: Creating Linkages Between SMEs and Private-Sector Firms in Industry and Services

Dr. Julia Devlin Ph.D.

Introduction :

Over the last hundred years the Kingdom of Saudi Arabia has made remarkable progress in establishing globally competitive resource-based industries, a vast physical and social infrastructure and the modernization of economic activity in agriculture and trade. Today development priorities are shifting towards deepening the base of productive activity, as exemplified by the Sixth Development Plan (1995–2000), which articulates goals of enhanced participation by the private sector, particularly in the development of human resources.

Traditional policy instruments designed to create a base for modern industry effectively maximized key linkages between the public sector, large private-sector firms and foreign companies. Broadening the base of private-sector activity, on the other hand, requires a different set of policy instruments: in particular, national planning to modernize the service sector, which houses substantial amounts of private-sector activity and expertise, as well as mechanisms to strengthen financial and human capital linkages between large and small firms in local development partnerships. This chapter adopts an institutionalist approach to expanding and deepening the base of the Saudi private sector via the promotion of service sector activity in the aggregate and enhancing linkages between large and small private-sector firms at the microeconomic level.¹

In Part I, a brief history of the Saudi private sector is presented, with special emphasis on the evolution of linkages between public and private sectors and with foreign firms complementary to industrial development. This section also addresses the importance of modernizing the service sector, which incorporates significant amounts of private-sector activity and is complementary to industrial development goals. Part II includes a description of small enterprises in Saudi Arabia today and of the benefits of encouraging increasing numbers of SMEs in industry and services. In Part III, policy recommendations designed to foster the business linkages between large private-sector firms and SMEs are presented in the form of suggestions for subcontracting, franchising and the outward processing trade, with suggested models for pilot programmes. Relevant experience from Egypt and Lebanon regarding the promotion of SMEs through business linkages between large and small firms is also discussed.

I. A. The evolution of the Saudi public–private partnership and institutional linkages Unlike Western conceptions of an industrial bourgeoisie, the Saudi formal private sector represents educated, urban groups bound by strong kinship ties who are largely operating in trade and commerce.2 Traditionally dominated by merchants, this sector formed a close relationship with the state during the oil-boom years by providing labour and imported equipment to facilitate the construction of massive infrastructure projects. From its traditional roots in the Hejaz, the Saudi private sector subsequently expanded to include a larger representation of political and business interests from the Nejd during the oil-boom years, as well as forging extensive links with foreign private-sector firms.³

In the 1950s and 1960s, for example, interaction between public and private sectors resembled a partnership based on consultative ties between the state and the traditional Hejazi merchant elite. Local chambers of commerce representing private-sector interests effectively monitored the registration of commercial and contracting firms, as well as the allocation of state subsidies and tariff legislation. The collection and provision of information regarding private-sector activity was a key component of the symbiotic relationship between the Saudi public and private sectors at this time.

By the 1970s, the core of private-sector activity had expanded to include the rise of Nejdi entrepreneurs with strong links to the state bureaucracy. Commensurate with this institutional shift was a domestic development strategy targeting wider segments of the local population, continued efforts to consolidate the national market and long-standing support for a laissez-faire economic philosophy. Public–private sector relations became redefined to incorporate an increasing emphasis on direct sectoral development by the Saudi State through interest-free loans and production subsidies administered by specialized funds in the agriculture, real estate, and other sectors.

Unlike other developing countries, where access to the domestic market is restricted, in Saudi Arabia most private-sector firms have been able to serve as intermediaries between the government and foreign interests, acting as independent contractors and entrepreneurs. Many large private-sector firms effectively supplied knowledge of local market conditions, while others acquired contracts, permits, and labour licences for foreign companies. In effect, the private sector played a critical role in mobilizing domestic resources for national development and expansion of the domestic market.

Industrial growth and development in the Kingdom since 1970 has been virtually unprecedented (see Table 13.1). Average annual growth in GDP from 1970 to 1980 was more than 10 per cent, in contrast with countries with roughly similar levels of per capita income and population, such as Chile, where GDP growth averaged less than 2 per cent for the same period. Labour-force growth in the Kingdom was also higher than average in relation to countries in Latin America and Asia, reflecting dramatic improvements in social infrastructure, economic activity and overall standards of living.

Table 13.1. Regional Development Perspectives

Country	GNP per capita US$ (1997)	Population in Millions	Avg. Annual GDP growth 1970–80	Avg. Annual Growth in Industry 1970–80	Avg. Annual Growth in Services 1970–80	Labour Force Growth 1970–80
Chile	5,020	15	1.8%	0.2%	2.8%	2.4%
Korea	10,550	46	9.6%	15.2%	9.6%	2.6%
S. Arabia	6,790	20	10.1%	10.2%	10.3%	5.5%
Venezuela	3,450	23	3.5%	0.5%	6.3%	4.8%

Source: World Bank.

In summary, the nature of the public–private and foreign enterprise relationship in Saudi Arabia in the post-oil period has evolved in conjunction with the Kingdom’s vast development needs. During the course of modern development, the Saudi State formed important linkages with local private-sector interests on the basis of information exchange and access to local networks of labour and capital, largely operating in the service sector. Joint ventures with foreign firms served primarily as a means towards the human capital and technology transfer required by the massive industrialization effort. Today, the demands of a modernizing economy require greater emphasis on promoting the service sector, which hosts significant private-sector activity, is complementary to industrial development objectives and has the potential to accommodate rapid labour-force growth within the Kingdom.

I. B. The need to modernize services

It is imperative that national planning in the Kingdom begin formally to incorporate development of a modern service sector. According to development economists, the service sector is widely acknowledged as maintaining well-defined complementarities and linkages with the general level of economic activity and development.⁴ It has the potential to create additional and higher-grade jobs, and to contribute to the enhanced efficiency, productivity and international competitiveness of the manufacturing and primary goods sectors, as well as to generate additional sources of foreign-exchange earnings and promote the health, education and social welfare of the general population.

Recent studies of service-sector activity in the industrial countries demonstrate significant employment potential. From 1985 to 1992, for example, business services as a group contributed virtually one in five of net additional jobs in the European Union, and for the longer period from 1960 to 1993, the average share of services in total employment increased from 42 per cent to 65 per cent for all industrial countries. In addition, the development of business services such as legal and accounting activities, consultancy and related professional activities is frequently correlated with an increasing complexity and sophistication of product lines through targeted marketing, shorter life cycles of products, widening of product lines and product differentiation. Service inputs represent roughly one- half of the sales price of manufactured goods in most industrialized countries. Increasing the component of services in goods assembly also translates into higher efficiency and productivity, particularly in the area of information technology.⁵

In Saudi Arabia today, services constitute the second most important source of economic activity behind industry (including oil), contributing roughly 18 per cent of GDP, although these figures also tend to reflect the importance of public administration and services. Private-sector activity in services has been relatively concentrated in trade, tourism and some financial services; but there is clearly demand for a broader array of service industries. On a global scale, Saudi Arabia’s service imports are roughly US$ 22 billion relative to US$ 3.5 billion exports in 1996, and the country ranks 17th in the world as a service-sector importer. Service imports are concentrated in communications, computer information services (89 per cent of total service imports in 1996) and transport services (9.5 per cent of total service imports in 1996).⁶

Enlargement of the service sector, particularly in the area of business services, would contribute to a more diversified productive base and broaden the economic participation of the private sector, as well as providing additional jobs and improving the competitiveness of the industrial sector. Saudi private-sector firms have long-standing expertise in service-sector activities through their knowledge of local market conditions. This clearly enhances the prospects of developing local service industries and the potential for co-operation with foreign service suppliers in adapting service products to the local markets, particularly in the area of business services.

At the macroeconomic level, broadening the base of the private sector requires a national policy applied to the service sector, complementary with policies and regulations concerning industrialization, investment, technology transfer, and licensing requirements, as well as national policies concerned with human capital development, transport and communications and telecommunications systems. The streamlining of regulatory frameworks to enforce business laws and contracts is needed, as well as more rapid progress on privatization, the harmonization of tax codes to avoid confusion, lack of understanding and inconsistencies within the tax system, and the gradual elimination of government pricing and government control of critical inputs. From the vantage point of foreign investment, local content requirements according to which multinational and regional firms purchase set quotas from the local markets should be reconsidered, since they tend to raise overall costs, by forcing companies to rely exclusively on local inputs, which can be more costly, resulting in the need for reimbursement by the government through tax holidays. Financial constraints could be eliminated by allowing increased participation by foreign and regional investors, and by the development of venture capital funds. Protection of intellectual property rights, the streamlining of labour legislation and a form of training of nationals that incorporates computer and customer service training are all needed to encourage the private sector to expand activities in domestic services. At the level of the microeconomy, local service activities can be encouraged through fostering business linkages between large and small firms built up through forging local development partnerships based on subcontracting, franchising and outward processing trade.

II. A. SMEs in the Kingdom of Saudi Arabia

Development planners in the Kingdom are clearly carving out a larger role for the private sector in the context of macroeconomic and structural reform initiatives such as fiscal retrenchment and financial and labour-market liberalization. With private-sector growth averaging roughly 7.1 per cent per year since 1967, and the sector’s contribution to GDP increasing from 11.8 per cent of GDP in 1974–5 to 45.3 per cent in 1993–4, the potential role of the private sector as an important engine of growth in the next century is promising.⁷ A microeconomic approach to broadening the base of private-sector activity consists of promoting business linkages between large and small private-sector firms to foster the growth of SMEs, which are relatively labour-intensive and encourage innovation and entrepreneurship In Saudi Arabia today, small and medium enterprises are playing an increasing role in generating productive output in industry and services as well as employment. According to local surveys, over 90 per cent of business establishments in Saudi Arabia have less than 20 employees, indicating a substantial number of small and medium-sized firms. Small firms in Saudi Arabia contribute significantly to social services and industrial development, representing more than 60 per cent of the total number of firms in sectors such as clothing, textiles and leather goods, wood products construction, glass, machinery and mineral products (see Table 13.2).

Table 13.2. A Sample of Small Firms in the Kingdom of Saudi Arabia, 1992

Sector	Total Number Small Firms	Small Firms in Sector As % Total Firms in Sector	Small Firms In Sector As % Total Small Firms
Food, Beverages	160	50.2	13.6
Clothing, Textiles, etc.	43	61.4	3.7
Wood Products	57	64.7	4.9
Paper, Printing	77	54.6	6.6
Chemicals, Plastics	147	43.0	12.5
Machines, Mineral Prod	368	62.8	31.3
Moving, Storage	12	57.1	1.0

Source: Riyadh Chamber of Commerce, Small Businesses in the Kingdom of Saudi Arabia, 1994.

The areas around Riyadh and Makkah (including Jeddah and Ta’if) house the largest concentration of small and medium-sized firms in the Kingdom. Small firms producing mineral products and machines are relatively important in each locality, followed by construction, glass and pottery, and food and beverages; and industry appears to dominate the activities of small firms overall. Small firms involved in the production of wood products and in the chemicals and plastic industries are fairly evenly distributed, while production of food, beverages, textiles and clothing is relatively concentrated in Riyadh, Makkah and Madinah. Smaller-scale service-providers in moving and storage, for example, are concentrated in Makkah and Madinah.

The majority of small businesses in Saudi Arabia have 40 employees or less, and these firms are predominantly structured as sole proprietorships. Sectors with the largest firms in terms of number of employees are concentrated in building and construction, social services, processing industries, transportation, and communications services. Small firms are also largely concentrated in the private sector, accounting for more than 70 per cent of the total number of private-sector firms and roughly 68 per cent of public-sector firms (see Table 13.4).

Table 13.3. Number of Small Industries in Each Area and as a Percentage of Total Small Industries in Each Area

Sector	Riyadh	Qasim	Makkah	Madinah	Eastern Areas	Gizzan	Najran
Food, Beverages	45 (11.2%)	6 (11.1%)	46 (16.9%)	13 (30.2%)	3.2 (10.9%)	4 (22.0%)	–
Textiles, Clothing	16 (4.0%)	1 (1.9%)	10 (3.7%)	6 (14.0%)	9 (3.1%)	–	–
Wood Products	25 (6.2%)	3 (5.6%)	8 (2.9%)	4 (9.3%)	16 (5.5%)	–	–
Paper Products	29 (7.2%)	2 (3.7%)	20 (7.4%)	1 (2.3%)	19 (6.5%)	1 (5.6%)	–
Chemicals, Plastics	42 (10.5%)	5 (9.2%)	36 (13.2%)	3 (7.0%)	49 (16.8%)	1 (5.6%)	–
Constriction, Glass, Pottery	88 (21.9)	13 (24.0%)	42 (15.4%)	7 (16.3%)	75 (25.7%)	9 (50.0%)	8 (80.0%)
Mineral, Machine Products	144 (35.8%)	18 (33.3%)	93 (34.3%)	6 (14.0%)	84 (38.8%)	2 (11.1%)	2 (20.0%)
Moving, Storage	1 (0.2%)	3 (5.6%)	3 (1.1%)	2 (4.6%)	1 (0.3%)	1 (2.56%)	–

Source: Riyadh Chamber of Commerce, Small Businesses in the Kingdom of Saudi Arabia, 1994.

Table 13.4. Small Firms in the Saudi

Private and Public Sectors

Sector	Less Than 20 Employees	Between 20 And 40 Employees	40 Employees Or Less	Small Firms As % Total Firms In Each Sector	Small Firms As % Total Small Firms
Public	741	150	891	68.2	8.0
Private	7,661	2,613	10,274	72.0	92.0

Source: Riyadh Chamber of Commerce, Small Businesses in the Kingdom of Saudi Arabia, 1994.

In general, small and medium-sized enterprises in the Kingdom suffer from financial difficulties, such as difficulties in obtaining bank loans, legal difficulties related to copyright problems, a lack of technically skilled personnel, and inability to secure access to basic services, such as telephone lines.⁸ Other difficulties include problems obtaining work permits, lack of market information and difficulties with recruitment and training, as well as lack of information on investment and expansion opportunities.

Small and medium-sized enterprises in retail and service sectors have little access to capital, while SMEs in industry receive loans from the SIDF, representing about 25 per cent of total SIDF financing.⁹ The bulk of financing for new small-scale ventures is therefore secured largely through equity participation, and most SMEs maintain a relatively low capital base (see Table 13.5).

Table 13.5. Capital Base of Small Industries in Saudi Arabia, 1992

Sector	No. Small Firms With < 1 Mn Riyals	No. Small Firms With > 1 Mn, < 3 Mn Riyals	No. Small Firms With > 3 Mn, < 5 Mn Riyals	No Small Firms With > 5 Mn, < 10 Mn Riyals
Food, Beverages	10	40	43	67
Clothing, Textiles	1	13	11	18
Wood Products	4	12	15	26
Paper Products	6	21	19	31
Chemicals, Plastics	1	33	47	66
Construction, Glass, Pottery	15	106	74	77
Machines, Mineral Products	24	123	93	128
Moving, Storage	3	2	7	12

Source: Riyadh Chamber of Commerce, Small Businesses in the Kingdom of Saudi Arabia, 1994.

Recent initiatives aimed at increasing financing opportunities for SMEs are a step in the right direction; but other policy measures are also required. A proposed industrial bank with lending facilities exclusively tailored to the needs of small and medium-scale ventures through the provision of soft loans is currently under consideration. In addition, the extension of additional loans to SMEs by Saudi commercial banks and venture-capital provision should be encouraged, particularly with regard to firms specializing in service-sector activities.

II.B. Why broaden the base of the Saudi private sector?

According to recent studies of SMEs in other developing and developed countries, the growth of small, independent, and interdependent firms based on local clusters and networks is of increasing value in the development of a competitive productive structure and the growth of domestic absorption capacity.¹⁰ The experience of SMEs in other developing regions suggests that smaller firms have lower capital requirements per worker and potentially higher productivity, strongly promote entrepreneurial effort, and allow greater flexibility and the creation of timely decision-making structures. In a competitive environment, SMEs are generally characterized by quick start-up times, remarkable innovative capacities and the ability to respond flexibly to shifts in the market.¹¹

External economies and firm clusters

Broad-based industry and services with strong inter-firm linkages promote external economies and lower transaction costs, thereby enhancing the efficiency of the productive base.¹² According to the insights of classical economists such as Alfred Marshall, external economies and spill-over can be enhanced through the grouping of industrial functions and pooling services between small, medium and large firms operating within formal and informal networks to develop new products, access new markets or develop new assembly processes. The importance of developing firm clusters and networks is that these allow for both horizontal and vertical linkages.¹³ Horizontal networks, for example, can provide access to new markets through cost-sharing on R&D activities, while vertical linkages can supply complementary activities in developing existing or new product lines. A vertical knowledge and service network, for example, promotes joint problem-solving techniques, as well as technology and market information-sharing activities.¹⁴

Transaction costs

According to the institutional economists, transaction costs, or constraints on exchange, are a primary determinant of firms’ organizational structures and sizes. ‘Make or buy’ decisions at the microeconomic level are clearly a function of information and processing costs, as well as of monitoring and enforcement costs connected with the legal and physical attributes of exchange.¹⁵ Indirect costs, such as the opportunity costs associated with queuing, satisfying bureaucratic requirements and licensing, also factor into a firm’s decision to produce in-house or to subcontract the assembly function.

In less-developed markets, for example, the preponderance of a dualistic productive structure consisting of very large and very small firms reflects to some extent the high transaction costs perpetuated by an ill-defined or weak market. If firms are unfamiliar with potential suppliers of inputs, this raises the costs of co-ordinating transactions with suppliers and heightens the motivation for vertical integration. In more developed markets, on the other hand, where potential suppliers are easily identifiable and information costs are low, exchange relations flow more efficiently, and become more standardized, leading to greater variety in the size of productive enterprises.¹⁶

In summary, the promotion of SMEs and business linkages between large and small firms appears to be correlated with external economies related to firm clusters and the lowering of transaction costs in the form of information asymmetries and other institutional obstacles to market access characteristic of less-developed economies. On the basis of the available evidence regarding small enterprises in the Kingdom, private-sector activity appears to be characterized by a dualistic productive structure consisting of very large firms and relatively small enterprises, with few enterprises in the median range. Policies aimed at broad-based development of the private sector will therefore need to incorporate more specific policy instruments designed to enhance the growth of small and medium-sized firms in industry and services.

III. Policy Instruments for Promoting SMEs in Saudi Arabia: Subcontracting, Franchising and Outward Processing Trade

SME development can be fostered through the subcontracting of industrial and service sector activities between large and small private-sector firms. In industry, for example, large-scale firms can utilize subcontracting to obtain semi-finished or finished products from first- and second-tier SMEs. Third- and fourth-tier SMEs can subsequently be mobilized by the additional subcontracting of the more labour- or technology-intensive functions required in the actual current stage of production. The creation of horizontal and vertical networks facilitates flows of raw materials, labour and information in conjunction with subcontracting operations. Government assistance programmes in marketing, technology acquisition and financial support may be needed, as has been the case in other developing regions.¹⁷

In the service industry, there are substantial opportunities for subcontracting arrangements between large and small firms. A recent survey of firms in Egypt, for example, revealed that 92 per cent of businesses interviewed were involved with some type of subcontracting arrangement based on linkages with medium- and large-scale firms, with more than 57 per cent of subcontracting occurring in the service sector, and roughly 22 per cent in manufacturing. A typical travel company in Port Said relies on smaller companies to supply cleaning, gardening, and camera and video equipment services, as well as guided tours, musicians, bakery goods, maintenance and transportation. In manufacturing, small workshops are subcontracted for operations such as the production of steel mesh or cast-iron moulds, and the bending and shaping of metal parts. For large business and multinational companies, the demands of high quality and high volume in a very strict time-frame frequently limit the linkages made to the large and medium-sized firms capable of handling such requirements.¹⁸

However, there are significant obstacles that need to be overcome in establishing subcontracting linkages between large and small firms. According to a recent survey of large firms engaged in subcontracting in Egypt, virtually 100 per cent of respondents cited the lack of quality control as being the most important obstacle to subcontracting. A further 60 per cent of respondents cited problems with management and delivery, together with the general skill level, as limiting small firms’ ability to produce quality goods and services.

In addition, almost 50 per cent of firms cited limited access to new technologies on the part of small firms, as well as lack of market information, as being significant obstacles to developing business linkages. The inability to market their products was also cited as a difficulty facing small firms. Lack of credit was noted by large firms as limiting small businesses’ access to appropriate machinery, technology and training, although only 25 per cent of large firms cited credit as a significant barrier to developing business linkages.

Other hurdles included transaction costs and a market structure that provides little incentive to encourage institutional mechanisms such as subcontracting. Frequently entrepreneurs cannot sustain the costs of association with unreliable partners, and the macroeconomic policy environment does not generally offset these costs. Policy and regulatory obstacles included the lack of uniformity and overlapping regulations, as well as cumbersome bureaucratic practices, ill-functioning legal networks and non-enforcement of intellectual property rights, burdensome tax systems, local-content requirements, and lack of proper training in the educational system.

One method of overcoming such barriers, particularly with regard to the lack of adequate training and quality control, is to establish training programmes for subcontractors. Glaxo Egypt is one company that provides a formal training programme for its staff and subcontractors that includes building quality training and skills up-grading programmes for its suppliers and subcontractors.¹⁹ Another approach is to establish a pilot subcontracting firm that provides commercially viable services but also teaches valuable job skills to the untrained and the unemployed (see Box 13.1).

Box 13.1. A Model Pilot Programme for Learning through Subcontracting

The Speedpak Solution

Speedpak Is A Short-Run, Contract Packaging And Subassembly Firm Whose Operations Include Subassembly Of Toys And Other Products As Well As Shrink-Wrapping Of Promotional Materials Used In Advertising Campaigns In An Attempt To Introduce A New Product, Such As Toothbrushes Attached To Boxes Containing Tubes Of Popular Brands Of Toothpaste. The Firm Also Specializes In Production Runs Of Promotional Items Or Seasonal Gifts That Are Typically Too Short To Be Of Interest To Large Domestic Packagers. Speedpak Offers Its Customers The Advantage Of Quick Turnaround In A Market Where Advertising And Seasonal Deadlines Make Foreign Outsourcing Unattractive. It Currently Employs 30 People, Many Drawn From The Ranks Of The Unemployed, And The Firm Is So Successful In Placing Its Employees In Other Jobs That It Can Recruit 30 New Staff Every Six Months.

Getting Started: The Basic Aim Was To Teach The Unemployed Problem-Solving Methods; And The Firm Subsequently Hired A Consultant, Who Was A Former Production Manager, To Determine Which Skills Contribute To Employability In The Local Area. The Consultant Conducted Informal Surveys Of Local Firms, Determining That The Ability To Work With Others In A Group To Solve Problems Was Perceived As A Necessary Precondition For Learning More Specific Training Skills Required In Other Jobs. With Limited Start-Up Capital The Firm Designed A Production Run That ‘Produced’ The Right Kinds Of Problems That Teams Would Need To Solve By Means Of Simple Technology That Constantly Had To Be Reconfigured To Meet New Demands On A Tight Schedule. Shrink-Wrapping Items For Time-Sensitive Markets Provided The Right Combination Of Technical Simplicity And Organizational Rigour, While Also Providing Potential Commercial Viability.

For A More Complete Discussion See C. Sabel, Ireland: Local Partnerships And Social Innovation, Oecd Publications, Paris, 1996.

Franchising

Franchising is another means of extending linkages between large and small firms, although its use is frequently limited by inefficiencies in the legal system. Arab companies, such as the Ness garment manufacturer in Egypt, have succeeded in developing a national market for their products by incorporating numbers of small firms as players in assembling the final products, provide new skills training to subcontractors as well as the purchase of new equipment for them. Other industries and services conducive to franchising include fast-food restaurants and other consumer-driven industries. Franchising offers benefits associated with communicating tried and tested business ideas, providing facilities for permanent mentoring by providing initial training and ongoing assistance to ensure that the franchise firm follows established procedures. It can also reduce the need for start-up capital, as well as reducing start-up time, thereby reducing the need for working capital, which is frequently a binding constraint for smaller businesses. Franchises are also more acceptable candidates for credit from financial institutions.

Policy measures to enhance business linkages via subcontracting and franchising include specific programming. In general, business linkages should be market-driven and satisfy existing needs in the business community. Partnerships between large and small firms can create a process of information-sharing and technology transfer and co-ordinate management skills and marketing in a mentoring environment. Information access for buyers and sellers is critical, since subcontracting and franchising also require the co-ordination of market research to identify backward and forward linkage opportunities, matchmaking through computerized databases to link up suppliers and buyers, monitoring to assist business partners through contractual and implementation stages, technical assistance, and a referral system to help clients access domestic assistance programmes.

Business brokers and professional business services are a key component for forming business linkages, and are generally limited in their availability, owing to a general lack of law offices and consulting firms as well as of formal brokerage houses. Business generally relies on family contacts and wasda to seek out business partners and economize on transaction costs; but this appears to limit exposure to more advanced technology, skills and management practices from larger firms. In Lebanon, for example, SMEs rely heavily on personal networks for day-to-day business operations for securing financing, suppliers, distributors and customers. Such informal networks reveal the presence of transaction costs, and, while they may improve market functioning, they also serve as a barrier to entry for outsiders or newcomers to the market. Such informal channels are also limited in their capacity to supply information on integrating new technologies, improving production organization, entering foreign markets and improving personnel management.²⁰ The absence of institutions providing standard business services and information such as market surveys imposes a significant constraint on SME activity in Lebanon.

Economic activities in Saudi Arabia that are easily amenable to creating linkages via subcontracting and franchising include food-processing and packaging materials, textiles and ready-made garments, as well as tourism and construction. In more industrial sectors, such as furniture and woodworking, and automotive feeder industries, such as metalworking and glass products, subcontracting offers significant potential for increasing employment intensity and diversification. Business services in the form of technological, engineering and marketing capacities are less well-developed, but offer potential subcontracting opportunities with foreign companies.

The potential for business linkages between large and small firms can be tested by means of a pilot programme. Preliminary surveys should be conducted for the purposes of sub-sector research in ready-made garments and services, for example, to determine the potential for establishing local development partnerships. The benefits of such linkages between large and small firms can be tested at low cost to determine the type of technical assistance and training required, as well as to provide an estimated cost for developing online database support in the identification of potential partner firms. To assess adequately the economic viability of developing business linkages that are mutually profitable, such a pilot programme should involve both key government bodies and large private-sector firms, as well as SMEs, in the planning stages (see Box 13.2).

Box 13.2. A Model Pilot Programme For Developing Business Linkages

The Plato Model

Plato Model: A Business Training Network Model Developed In Belgium In Which Small Firms Aiming To Grow Established Companies Through Expansion Into Foreign Markets Are Linked With Managers Of Local Large Companies In A Mentoring Process. The Objectives Of The Programme Are To Establish Broadly Based Business-To-Business Support Structures That Provide Opportunities For Sme Owner/Managers To Develop Their Management Skills And Create Opportunities For Commercial Development Through Local And International Networking.

Criteria Necessary For The Programme To Work Include An Sme Base Of 500 Suitable Companies With At Least 80–100 Potential Participants And At Least 10 Large Companies With Over 20 Managers Willing To Participate Within A Prescribed Geographic Area. Participating Firms Are Selected By Plato Staff, Who Conduct Interviews With The Owner/Managers Of Prospective Members, And Companies Are Judged On The Basis Of Criteria Such As The Desire To Expand, To Access New Markets Or To Commercialize Products. Smes Selected From Participation Are Grouped With Companies Of Similar Dimensions Or Sectors To Ensure That The Issues Raised Are Of General Interest.

Participants Learn To Exchange Ideas Openly And Group Projects And Discussion Focus On Basic Themes Such As Industrial Relations And Time-Management, As Well As Quality Control. Leaders Chosen From Large Firms To Guide The Groups Are Specialists In Quality Control, Logistics, Production Management Or Industrial Engineering. The Partnership Provides A Framework In Which Training Services Are Tailored To The Particular Needs Of The Member Firms; And By Training Together Firms Can Purchase The Consulting Services They Need From Public And Private Providers On Better Terms. Large Firms Or Parent Companies That Initially See Their Participation As A Public Service Have Frequently Noted The Beneficial Effect Of Acting As Group Leader On Their Own Executives. In Addition, The Choice Of Group Leaders From Production-Related Specialities Alerts Them To Small Firms In The Area That Are Beginning To Modernize And May Serve As Future Suppliers Of Products And Services.

Implementation of a pilot programme to developing linkages between large and small private-sector firms also requires complementary policies in providing credit access to small firms, and market surveys and financial incentives to large firms. In the area of finance, increased lending by the banking sector to small and medium enterprises, for example, should be focused as much as possible on the provision of working rather than fixed capital. Lack of access to working capital and excess capacity generally poses more significant barriers to entry and sources of inefficiency for small-scale firms than does fixed investment capital. Initial loans should be small and structured for short-term repayment schedules, with new loans conditional on the repayment of existing loans. Interest rates should be high enough to cover operating expenses, including the costs of funds.²¹

Non-financial assistance to SMEs may include marketing surveys and technological support, frequently an important missing ingredient for smaller-scale firms. These should be industry and task-specific to accommodate the needs of a particular product group. Schemes, which assist existing firms, are also more likely to be successful than those, which seek to establish new firms. Industrial estate projects frequently lock in too many missing ingredients to firms that may need only one or two of these services.²²

Local development partnerships between large and small firms can also be enhanced through a government-sponsored computerized clearinghouse, which, for example, can serve to link component-producing companies with component-using companies. Companies that register with the exchange should provide detailed information on their products and production capacities, although independent monitoring of the capability of different suppliers and buyers would also be an optimal desideratum. Large enterprises can be awarded a subsidy (5 per cent of the total amount purchased) for securing components from a smaller enterprise registered in the government programme. Computerized exchange services should be provided free of charge to small and medium-sized firms.

Tax incentives can be structured to avoid tax-cascading effects, in which products are subject to turnover or sales taxes each time they change hands. Similar adjustments should also apply to tariff rates to ensure that parent firms are not discouraged from subcontracting by producing in-house to lock in favourable import duties on inputs. Although corporate taxes in the Kingdom are relatively low in comparison with international standards, some form of tax rebate for large firms purchasing inputs from SMEs would serve as an incentive to induce their subcontracting of productive functions. Large-scale firms can also be given incentives to ‘adopt’ SMEs as their subcontractors, as well as for the purpose of upgrading the technological capability of SMEs. Joint product and process research between parent firms and SMEs might serve as another component of this partnership programme (see Box 13.2).

Publicity and training are critical for making businessmen aware of the potential benefits to be derived from subcontracting, as well as for the functioning of agents who link parent firms and suppliers. Training in the areas of record-keeping and financial arrangements for all actors involved is critical for facilitating subcontracting functions, since the viability of the entire system hinges on the record-keeping and financial abilities of such agents.

Policy measures aimed at creating linkages between large and small firms should also include general policies, such as capital market liberalization, and labour market reforms. Fiscal conservatism, through the gradual lowering of subsidies on utilities, goods and services, in conjunction with microeconomic policies targeting the streamlining of financial and labour market regulations, is critical for enhancing the predictability of the macroeconomic environment in which firms operate.

Outward Processing Trade (OPT)

Outward processing trade (OPT) is a form of intra-industry trade that is conducive to foreign investment as well as technology transfer and skill accumulation. This process consists of shipping components for assembly from a retailer/suppliers to a regionally based firm where labour costs are relatively cheaper and further processing occurs. The processed good is then exported back to the principal supplier under preferential rates of duty.

OPT offers incentives for private-sector investment by reducing the costs and risks associated with the development of international and regional export markets. It can also serve as an important vehicle for technology transfer, learning by doing and skill accumulation, where it involves the subcontracting of activities such as product design, quality monitoring and marketing. Given the rising interest in developing export processing zones in the Kingdom, OPT would clearly offer additional opportunities to broaden private-sector activity by incremental processing and value added to products destined for re-export.

OPT has been an important mechanism for increasing intra-industry trade between Central European and Eastern Countries (CEEC) and the EU, but has been relatively limited in use among Arab states, with the exception of Morocco and Tunisia, where it has been used intensively for sectors such as garments, leather goods, electrical machinery and furniture.²³ For the Middle East/North Africa region as a whole, OPT represented less than 2 per cent of exports to the EU in 1993, by contrast with Eastern Europe, where it accounted for 18 per cent of total exports to the EU. Given increasing levels of intra-industry trade for the majority of Arab states during the mid-1990s, there are substantial gains from international and regionally based OPT.

However, in order to increase the local skill component, there is a need to couple OPT with deeper firm-to-firm linkages such as subcontracting, franchising or intra-firm trade. Sectors with attractive regional and foreign investment prospects in the Kingdom of Saudi Arabia today include sectors with high revealed comparative advantage, such as chemicals and/or niche export markets.

IV. Conclusion

The tremendous achievements in growth of economic activity, improvement in living standards and expansion of a social and productive base in the Kingdom of Saudi Arabia over the last decades are unprecedented in the history of human civilization. Underpinning this dramatic growth achievement is an institutionalized public–private partnership evolving from the creation of a unified national market under the umbrella of the Saudi state, and traditional centres of commercial expertise in the Hejaz and entrepreneurial activity in the Nejd. Today, there is a need for a comprehensive review of institutional mechanisms designed to widen participation in the processes of change within the economy and society.

Experience from other developed and developing regions suggests that expansion of the service sector at the macroeconomic level and microeconomic incentives targeting the growth of small and medium-sized industries are effective means of broadening the base of private-sector activity. Firm linkages and the promotion of SMEs via institutionalized subcontracting, franchising and outward processing trade are complementary to ongoing industrialization efforts and the mobilization of financial and labour resources at the grass- roots level. By fostering entrepreneurship and the promotion of a ‘self-help’ business environment, SMEs also support the development of local entrepreneurial talent by providing role models, exposure and networks into the independent business process.

Notes

1 Given the standard classification of SMEs as firms with more than five employees and less than 200 employees, most of the firms in this study qualify as small enterprises rather than as medium enterprises, owing to the unavailability of data on larger enterprises in the Kingdom. Collection and analysis of survey data on medium-sized firms would present an important opportunity for future research.

2 Andrew Hess, ‘Peace and Political Reform in the Gulf: The Private Sector’, Journal of International Affairs, Summer (1995): 103–22.

3 K. Chaudhury, The Price of Wealth: Economies and Institutions in the Middle East, Cornell University Press, Ithaca, NY, 1997.

4 Bimal Ghosh, Gains from Global Linkages: Trade in Services and Movements of Persons, International Organization for Migration, Paris/Macmillan Press, New York, 1997.

5 Ibid.

6 Reported on the basis of data from UNCTAD, the World Bank, and the IMF. Data sources as reported in Ghosh, Gains from Global Linkages.

7 ‘Privatization to Further Boost Kingdom’s Economy’, Moneyclips, 20 August 1997.

8 Syra House, ‘New Services to Small & Medium Businesses’, Report prepared for the Jeddah Chamber of Commerce and Industry, 1994.

9 Javid Hassan, ‘Establishment of Industrial Bank Found Viable’, Moneyclips, 2 February 1997.

10 OECD, Networks of Enterprises and Local Development, OECD Publications, Paris, 1996.

11 For a more complete discussion of small-scale industries in developing countries, see C. Liedholm and Donald Mead, ‘Small Scale Industries in Developing Countries: Empirical Evidence and Policy Implications’, Michigan State University International Development Papers, Department of Agricultural Economics, East Lansing, MI, 1987.

12 Saha D. Meyanathan (ed.), Industrial Structures and the Development of Small and Medium Enterprise Linkages: Examples from East Asia, EDI Seminar Series, World Bank, Washington, DC, 1994.

13 For a more complete discussion, see Sergio Arzeni and Jean-Pierre Pellegrin, ‘Entrepreneurship and Local Development’, OECD Observer, 12 Feb. 1997.

14 Ibid.

15 Meyanathan (ed.), Industrial Structures and the Development of Small and Medium Enterprise Linkages.

16 Michael Porter, The Competitive Advantage of Nations, The Free Press, New York, 1990.

17 Jose Campos and Hilton Root, The Key to the Asian Miracle: Making Shared Growth Credible, Brookings Institution, Washington, DC, 1996.

18 Janice Stallard and Dalia Abdel Hady, Working Side By Side: Small, Medium & Large Businesses Working Together in Egypt. A Report published in collaboration with the National Cooperative Business Association (USA) and Environmental Quality International (Egypt), 1996.

19 Ibid.

20 World Bank, ‘Small and Medium Sized Enterprises in Lebanon: A Preliminary Assessment’, World Bank Private Sector Development Draft Paper, 1994.

21 C. Liedholm and D. Mead, ‘Small Scale Industries in Developing Countries: Empirical Evidence and Policy Implications’, Michigan State University International Development Papers No. 9, Department of Agricultural Economics, East Lansing, MI, 1987.

22 Ibid.

23 B. Hoekman, ‘The World Trade Organization, the European Union and the Arab World’, World Bank Policy Research Working Paper No. 1513. 1995.

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