Tuesday, 7 September 2010

Small enough to fail - alas

I had never heard of ShoreBank until I read this article in The Economist. The Economist titled its article – Small enough to fail. I add an “alas” to my post header.

ShoreBank , according to The Economist article, thrived for 35 years on a business model of a small community bank that targeted lending to poor people in poor neighbourhoods. It actually had higher repayment rates and lower delinquency,  as any careful micro lender will tell you.  But then the recession struck like a tsunami. In the neighbourhood in  which it operated, the recession has been brutal and most people lost their jobs. Despite very good payment records in the past, they couldn’t keep it up.  Unfortunately its location in Chicago and therefore the association with Obama made it a political lightning rod. No way it could be bailed out. Alas, it had to go.

This article set me thinking on the risk quotient for small businesses. By definition, small businesses cannot be diversified in terms of risk. They will be dependent on either a small market, or a small set of suppliers, or a particular technology or a single currency, or whatever. Even if they are an extremely well run business, they can be vulnerable to a violent swing in risk parameters over which they have no control. Exactly what happened to ShoreBank.

It must be remembered that some 90% of all businesses in the world are small businesses. They are, by far, the largest employers in the world.  Are they fundamentally vulnerable ?  And therefore at a fundamental competitive disadvantage over big businesses ?

Traditional risk mitigation strategies involve either hedging or taking insurance.  Both don’t seem to be attractive options here. Can small businesses pool together and hedge together ? Can some intermediary create a product that can help make this happen ?

These days, I am working with a small entrepreneur whose business has gone bad. What he and his family are going through has to be seen at close quarters to be appreciated. Risk is an esoteric term in economics text books. When it hits lives brutally, it stops being a concept and starts to become something frighteningly real. Small businesses face it every day , in ways  that big businesses would not even comprehend.  And yet, risk mitigation seems that much more difficult for small businesses.

This is a muse, without a point of view. I just wonder if risk management products must be evolved for systemic risks faced by small businesses. And just one other thing. The next time you delay a payment to a small guy, or squeeze him in a negotiation, just pause and spare a thought.


  1. To answer your both the questions, The answer is YES. Small businesses are fundamentally vulnerable and are at competitive disadvantage. You have very clearly said, they are hit by things for which they do not have any control over it.
    Can small business succeed or not also depends on, the nature of business and "what and how you define small"
    Oh and you dont need a recession to kill the small companies.There is some thought liberalization did kill such small Indian companies.[In tamil nadu they used to say Coke killed kalimark paneer soda]
    There could be some optimists never say die attitude people saying, "All things started in a small way" thousand mile journey starts with one single small step. But, most of them are fairy tale stories!

  2. great post from you Ramesh. While the urge to keep moving up and large does exist, there is no ecosystem to foster and encourage the next generation of small businesses. We seem to beleive in the mantra that something which is not scalable is not fashionable.

  3. hmm....if people starts to buy shoes from road side cobblers..by placing their trust on them not just to mend their 1000 buck shoe but also in believing their product..it wud go a long way in abolishment of "999.99" only tags and also in empowering those little entrepreneurs. large looks attractive and easy to attack too incase of defects while small suffers from lack of the same. I personally feel gone are the days of cheap and best. Nowadays more expensive more the merry happens to be the tune :)

    kalimark vera paneer soda vera i guess..and enga areala stl u get agmark paneer soda..mylapore vantha solunga..oru gulp adikalam :)

  4. @zeno - Yes, many small businesses will fall by the wayside . My muse was the impact of systemic risk on even well performing small businesses like ShoreBank, say. Good to see you back after a small hiatus.

    @Sabareesan - Very intersting point. Is it really true that not scalable is not fashionable. There are clear diseconomies of scale too. Perhaps food for a future post.

    @gils - Oh no - only very rich and single people like gils can be "expensive and merry" !! Can I come too for the paneer soda .....

  5. thala ungalukillatha paneer sodava...anytime.

  6. Micro finance guys always encounter such problem,there should be a risk model definitely.

    @ gils: You are right.Both sodas are different

    Panneer soda will have the smell of panneer,it available in old cocacola,pepsi bottles right from 3 to 5 rs,basically you should get it any potti kadai.Its one of my favorite.

  7. A friend's FIL also runs a small manufacturing unit, and the recession had really been tough for him. There was nothing he could do about demand. The machinery had to be maintained, the labourers were getting frustrated with late payments. I know what you're saying.

    Maybe forming small consortiums could help. Systemic pressures could be handled better by a group than a single entity. Not that it would mitigate the risks, but it could improve immunity. (Me is just thinking out loud here, probably very simplistically too.)

  8. Ahhhh!! right time to read this post as someone I know is hard on a negotiation that is going south. I have half a mind to circulate this to the actual intended readers:)

  9. Hi Ramesh,

    Failure rate of smaller businesses is much higher than larger businesses but if you look at sheer size of an Enron failing would be much more damaging that a few thousand small businesses collapsing (overall eco-system of employees, shareholders, government, pension funds etc).

    Also another thing is somehow I feel smaller or medium businesses are far more business minded (risk takers) rather than risk intelligent (risk averse) large conglomorates. A business idea which may be good but small may get stuck in the red tape of presentation, approval by boss, approval by steering committee, approval by board members by which time the business idea is lost or the person has moved on to his next job. most of these companies failing would never take off as an idea in bigger banks and yet these banks almost/failed 2 years back.

    On a lighter note - why not send all these small businesses to the big 4. I am sure they can sell them some gyan on risk management and take away all their money - no money left - so no risk and no bankruptcy... :)


  10. Great post Ramesh as always... I think small businesses have that inherent risk of being prone to upheaval due to any external or internal factors. Scales and diversity of operation help big companies in sustaining those risks (not like Enron for sure). But, for small ones, options are too limited and difficult to execute.

  11. You bring up some interesting issues here. Yes, size is viewed as a risk factor in many asset pricing models as smaller companies tend to be more sensitive to macro risk factors precisely for the reasons you cite - lack of diversification in operations and also low equity to cushion shocks. But then that is only the systematic portion of risk. Most finance theorists would wish to ignore the more idiosyncratic risk that can be diversified away. But many of these entrepreneurs (and investors) in smaller private companies hold concentrated holdings plus their human capital is tied to the firm. So it would be interesting to think about a product that would at least get them to the level of risk exposure of a diversified investor. May be an industry association where they can figure out a way of at least cross-hedging their activities or getting some diversification benefits. But the challenge is finding a contract that would provide them the risk management without killing their own incentives and at the right cost. I have no idea what it would look like....

    Interestingly, Shorebank itself continues under the new management backed by all the big names! So after all there is something right about the business model in the niche market and investors are still willing to invest. But it appears that Shorebank did get a bit carried away in recent years with their mortgage lending which caused them to fail. I wonder what happened to the original founders.

  12. @AA - Well, we should form a paneer soda fan club !

    @Deepa - Yes, some form of pooling together is a probable way forward.

    @Priya - Such a tough world it is , for small entrepreneurs. We can only wish your friend the best.

    @Mahesh - No, I feel the many small businesses that fail cause more mayhem than an Enron. I can understand small businesses failing for bad management or business specific risks. The ones that are "unfair" are the systemic risks.

    @Vishal - Yes, its a tough one to create and execute.

    @J - Yes Shorebank got the big boys investing in - I think there was partly the allure of social banking which drove them there. The founders seem to have been taken out - no doubt they will surface somewhere.

  13. Dear Ramesh, being a small entrepreneur, I can relate to the feelings expressed, and indeed, these are feelings I have shared with you. The only assets a very small company has are good ideas, a small set of committed people, and agility. Yet, I wake up every morning in dread, and at the same time, once I get to work, things seem to fall into place - for the moment. A friend once reminded me of the Stockdale Syndrome. This is exactly how it feels. I sympathise with the entrepreneur you mentioned. When faced with adversity people will do terrible things that would not be acceptable normally.

  14. Sandhya Sriram10/9/10

    There is a portal called website outlook. according to that, it seems your blogs are worth US $ 1408.9 and has a 16777215 traffic rank. you can check out here(http://www.websiteoutlook.com/www.indigoite.blogspot.com)

    you should ask the 65 readers daily what it means to them. for someone like me, it is the most precious thing which i have ever bumped into in my life and is my daily dose of a visionary's perspective on mundane business.

    i guess, that is what it is for small businesses. they may be small, they may be vulnerable, they may be risky, but for the small group associated with it, they are very important.

    end of the day, darwin's theory of survival applies to every being - risk and return of business applies to every organization irrespective of scale. Each person has to evolve and emerge as each living being has to survive on its own feet. some get washed out - it pains the one which are closest to it, but it makes the breed stronger and find ways to evolve better.

    sorry for being so philosophical on a business topic.

  15. @Ravi - I know exactly what you mean. And your las statement is so true - people indeed do crazy things when faced with adversity. I have a feeling that big risk taking makes you virtually lose your logical reasoning.

  16. @Sandhya - Wow. Thanks for the millionth time for your kindness. Continue to be bowled over by your encouraging words. The Darwinian analogy is an intriguing one. Business indeed is about survival of the fittest. One of the dimensions of being the fittest is t manage risk effectively and I wonder if small businesses can find more effective ways.


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