The Rise of SME Tech

Why SMEs

After many years of development, the consumer tech space has been saturated, and it’s rare to find consumer-facing startups that have the potential as what Facebook or TikTok had at their early stage. Most of the big opportunities such as mobility, B2C logistics, and B2C e-commerce have been captured already. The relatively low market-entry barrier and the high scalability nature of B2C businesses always attracts the best talents and the most funding at the very early stage.

On the other hand, enterprise B2B technologies have also been well developed in many markets because it is very attractive to entrepreneurs due to the nature of large business customers. Large enterprises typically have higher willingness and ability to pay, and the market is reasonably concentrated.

When it comes to small-to-medium enterprises (SMEs), the situation is very different. There are four reasons that the SME market is less attractive to entrepreneurs. 

1. Compared to selling directly to consumers, selling to SMEs has a relatively longer sales cycle, resulting in a lower user growth rate – a lower scalability in terms of customer base. 
2. Compared to large enterprises, SMEs usually have a lower purchasing power and a lower stability, which means a higher churn rate.
3. Compared to large enterprises, SMEs are highly fragmented, meaning a lower ROI on startups’ marketing budget and a lower scalability in terms of revenue.
4. Compared to startups targeting large enterprises, companies selling to SMEs can hardly build a high market barrier by dominating a large share of the market, resulting in a high level of competition at a later stage once the business model has been validated.

	Consumers	SMEs	Enterprises
Scalability	Extremely high	Medium	Low
Contract/Ticket Size/Purchasing Power	Small	Medium	Large
Price Sensitivity	High	Medium – High	Medium
Sales Cycle	Short	Short – Medium	Long
Product Standardization Level	High	High	Medium – High (Customizations are often required)
Market Concentration	Low	Low	High
Potential Competition Outcome	Monopoly/Oligopoly	Oligopoly or no dominant	Monopoly/Oligopoly
Market Barrier (non-tech part)	Low	Medium	High

Therefore, the nature and dynamics of the SME market makes this group of customers less attractive to entrepreneurs and leaves this huge market underserved. However, a huge underserved market means a huge potential opportunity. In many countries SMEs are a major contributor to the local economy. For example, with 34% of its GDP coming from informal businesses, Latin America and the Caribbean is the region with the most active informal economy in the world. For some other regions like  Sub-Saharan Africa and South Asia SMEs also contribute more than 30% of the local GDP.

A research paper from the Wharton School presents 4 major challenges that LatAm SMEs are facing: (1) technology that falls behind; (2) underdeveloped human capital; (3) an obstacle known as ‘marketing’; (4) restrictions on loans.

1. Technology that Falls Behind: SMEs invest comparatively little in technology. And when they do, often they acquire equipment, machinery and software that is inappropriate. Why? “Because, in order to modernize yourself, the first thing you have to do is to focus on the core of the business and only later think about technology,” notes Juan Carlos López, an executive at Neoris, a multinational consulting firm.
2. Underdeveloped Human Capital: In most small Latin American companies, the dominant way to get hired is through personal recommendations, notes Andrés Escobar, an economist at the University of Andes and specialist in public administration. Juan Carlos Echeverry, professor at the University of the Andes, agrees. “Small and medium-sized companies often lack career planning programs because they don’t have appropriate hiring practices that identify job candidates’ skills, weaknesses, aptitudes and knowledge.”
3. Lack of Marketing: Experts agree that SMEs know how to produce goods but they often don’t know how to sell them. “They have a hard time adopting a marketing strategy in which the focus of the business is the customer; in which markets are segmented, new business opportunities become more visible, and a company moves into new areas,” says Ángela Enríquez, a marketing expert and dean of the Sergio Arboleda University, based in Bogotá.
4. Restrictions on Loans: Loans are a scarce resource for SMEs for a variety of reasons: their informal [or underground] nature; the administrative disorder that characterizes some SMEs; their lack of leadership; the absence of real [loan] guarantees; and a shortage of [business] information [about small companies]. 

To sum up, when both the B2C and the large enterprise B2B markets have become saturated, many entrepreneurs start to pursue the colossal opportunities in the underserved SME market by fulfilling the unmet demand from SMEs.

A large portion of SMEs are focusing on emerging markets which are highly fragmented and underserved. Emerging markets today are the world’s main drivers of global growth and wealth accumulation. They cover a dominant share of the world’s population and natural resources. Emerging market countries represent 59% of the total global GDP (based on PPP-adjusted USD), which is a significant expansion over the past years; in 2006 these countries represented less than half of global GDP. 

Companies in the SME tech space

Investment opportunities in SME tech

SMEs in the major markets

Given the nature of SME markets, investors care most about the potential market size – where the SME tech startups can have the highest scalability. Based on the data from the World Bank, there are 28 markets that have more than one million micro/small/medium-sized enterprises (MSMEs).

Beyond the number of SMEs, investors would also like to consider the availability of technologies tailored to SMEs. For example, the US market is fairly developed with many tech solutions tailored to SMEs, and this means there are limited new opportunities for entrepreneurs. However, for markets such as Indonesia, Nigeria, Brazil, Mexico, Bangladesh, Pakistan, Egypt, Thailand, Kenya, Colombia, and Peru, the local tech markets are still in their early stage, and most of the existing startups are focusing on consumers. The SME market has been left far behind.

Economy	Year	Number of Enterprises, MSMEs	Population	Source of MSME Data	Income Group	Number of Employees, Total MSMEs
China	2013	56,061,600	1,350,695,000	SAIC	Upper middle	72,369,000
United States	2010	27,827,900	309,326,225	SBA	High	77,107,300
Indonesia	2008	22,655,831		INDMinSME&Coop	Lower middle
Nigeria	2004	8,400,000		USAID/Chemonics Inc.	Low
Brazil	2011	5,109,076	196,935,134	IBGE	Upper middle	27,655,533
Italy	2011	3,840,274	60,723,569	SBS Eurostat	High	11,754,830
Mexico	2008	3,656,619	114,968,039	INEGI	Upper middle	13,622,701
Korea, Rep.	2012	3,599,133	50,004,000	KOSIS	High: OECD	15,980,795
Tanzania	2012	3,000,000	47,783,107	UNIDO	Low	5,200,000
Bangladesh	2003	2,987,560		BBS	Low
Pakistan	2005	2,911,751		PFBS	Low
Turkey	2011	2,587,319	73,058,638	TSI – Turkish Statistical Institute	Upper middle	6,213,363
Egypt, Arab Rep.	2006	2,453,567	72,990,754	AFDB	Lower middle	7,745,270
Thailand	2006	2,264,525		OSMEP	Lower middle
Spain	2011	2,239,814	46,174,601	SBS Eurostat	High	8,129,205
Australia	2011	2,134,872	22,323,900	ABS	High	7,407,000
France	2011	2,132,690	65,371,613	SBS Eurostat	High	8,250,752
Germany	2011	1,904,661	81,797,673	SBS Eurostat	High	14,612,268
Canada	2010	1,743,753	34,126,547	INDCA	High	7,399,285
United Kingdom	2011	1,690,730	62,752,472	SBS Eurostat	High	6,444,282
Russian Federation	2010	1,669,439	142,960,000	EIB	High: non-OECD	13,731,900
Kenya	2006	1,600,000		MTI	Low
India	2006	1,564,000	1,143,289,350	MinMSME	Low	9,309,000
Poland	2010	1,477,008	38,183,683	SBS Eurostat	Upper middle	5,644,691
Colombia	2005	1,389,698	43,184,026	MinCIT	Lower middle
Taiwan, China	2011	1,279,784	23,262,000	SMEA	High	8,337,000
Iran, Islamic Rep.	1997	1,255,382	62,542,531	UNIDO	Upper middle	709,295
Peru	2010	1,197,963	29,262,830	CODEMYPE	Upper middle

Key metrics for evaluating investment opportunities

When it comes to evaluating investment opportunities, the market size is one of the key factors similarly to B2C and large enterprise B2B markets. Because the SME market is typically very fragmented, a startup would only acquire a small percentage of the market at best. Therefore, a massive market is a MUST for investors to consider an investment.

For example, for startups providing fintech, supply chain and logistics, and e-commerce solutions to SMEs, the following metrics may be a good starting point to narrow down the opportunities when sourcing and evaluating startups.

1. $ of TPV (Total Payment Volume)
2. # of end customers (consumers)
3. # of restaurants, hotels, clinics, mom-and-pop grocery shops, brick and mortar retail stores, etc.
4. # of grocery/e-commerce/D2C retail deliveries
5. $ of ticket size
6. # and size of incumbent players in respective market
7. $ of resident income and spending
8. National currency volatility
9. Political and infrastructure stability

Business models for SME-tech startups

SME-tech startups will usually use the following business models. 

1. SaaS-based subscription fee
2. % of transaction volume as transaction fee
3. Commissions from sellers and/or buyers for marketplaces
4. Interest revenue from customer deposit
5. Revenue share with SMEs
6. Profit/Cost-savings share with SMEs
7. Platform model (e.g. Facebook, Twitter) – offering free products/services to end users while monetizing users through other channels (advertising, marketing, data analytics)

However, investors may have different preferences about the business models. Different business models mean different growth potentials. For example, given that the SME market is highly fragmented and that SMEs have a low willingness to pay, using a SaaS-based subscription fee model will indicate a limited potential of the business.

Different business models mean different growth speeds. For example, charging a SaaS-based monthly subscription fee will mean an upfront cost for SMEs, making it difficult to sell the product. While sharing the extra revenue/profit from using the startup’s product with SMEs will sound more acceptable to SMEs and make it easier to acquire those customers.

Success factors for SME-tech startups

The success factors for SME-tech startups are similar to those for the other startups. For early-stage investment opportunities, the team comes right after the market size. Since the problems faced by SMEs are very different from the challenges faced by large enterprises or consumers, the right founding team should have deep knowledge about the SMEs’ pain points in the targeting industry and solid experience in communicating with the SMEs.

Specifically, since most of the tech solutions for SMEs are not new deep technologies but applications tailored for SMEs, experience in user growth in the SME space will be very important.

1. Team with solid experience in the relevant industry
2. Team with understanding of the respective market dynamics
3. Team with strong business development experience working with SMEs
4. Team with strong product development experience
5. Team with quick go-to-market capabilities
6. Validated and clear product value proposition and high product scalability 
7. Product that is easy to deploy
8. Business model that is sensible for the market and potential customer persona 
9. Low customer acquisition cost

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This research is co-authored by Fan Wen and Janis Skriveris at Plug and Play Ventures.

Disclaimer: The article is not, and should not be regarded as “investment advice” or as a “recommendation” regarding a course of action, including without limitation as those terms are used in any applicable law or regulation.

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Appendix

The following data is collected from Crunchbase, PitchBook, Tracxn, and LinkedIn. Please visit the companies’ official websites for more information.