Walking round the Nairobi Central Business District (C.B.D) the other day, I was bemused by just how so many businesses are similar. One is bombarded by cyber cafes, mobile phone shops and clothes retailers. To me it is very amusing that within one bazaar, from out of 12 shops, 7 of them sell mobile phones while the other 5 sell clothes. It is representative of the insatiable entrepreneurial spirit that Kenyans possess as well as maybe a lack of innovation and imagination within society. It could be that low levels of tertiary education and rigid rules concerning small enterprises in Kenya warrant this over indulgence in the aforementioned businesses. They could be thought of as the trinity of businesses amongst I would dare say people who lack a specific personal skill acquired through tertiary education.
Is the situation any different amongst workers who have attained a university degree or beyond? Probably not, most young Kenyan workers educated both home and abroad mostly engage in similar enterprise. A marketing consulting firm, an accounting firm, a corporate communications firm or a media firm are the usual suspects. The breadth of business ideas is very narrow. This is not to say that the businesses mentioned are not profitable. Among the Top 100 Small and Medium Enterprises (SME's), rated by Business Daily and KPMG 12 of them operate within the fields I have just mentioned. Therefore when run well, they can be very profitable enterprises. In the short run, they can be an investor's best dream as they generate good cash flows and have a high Return on Assets (ROA); this is a measure of the profit gained per shilling of assets. Since the value of the asset is the denominator, it is a measure of how well you use your assets to generate income.
The question then is why is this of any significance to someone who is concerned about our economy? My response is based on an analysis of a perfectly competitive industry.
Perfect competition occurs when there are many buyers and sellers of the same product, selling a homogenous (similar product), within a system that has perfect or near perfect information (where buyers and sellers know everything about each other's prices and output) all leading to a situation where firms make zero economic profits adjusted for risk. An example can be given of the wheat industry in our imaginary province Ungaland. In Ungaland, there is an abundance of land where wheat can be grown. In the province, the population has split itself into two groups; wheat growers and wheat buyers. If one farmer were to start growing wheat and everyone else was buying from him, he would make supernormal profits since he determines his output and therefore price. When other Ungaland citizens take cognisance of this, they will all rush to become farmers so as to also make economic profits. This will happen up to the point where they are no longer making profits as they increased supply will see them sell at a point where the price of the bushel of wheat sold at the market is equal to the cost incurred by the farmer to produce that bushel of wheat.
Here the distinction of economic profits is made because in economics, one has to take into consideration of the opportunity cost. This is the cost of the best alternative activity foregone due to undertaking the farming. The farmer could have become a fisherman or maybe would have put the funds he used to start the farm into an interest bearing account. The benefits that would have accrued from these activities are the opportunity cost. Accounting profit on the other hand just reflects explicit (stated) costs and benefits. From this, the implication is that after adjusting for opportunity costs, the farmers are not being compensated for their foregone opportunities.
If one now applies this to the situation with both "skilled" and "unskilled" workers and I call them that with extreme caution since some of the "unskilled" workers are very skilled at a particular vocation, one observes that the markets for their goods and services are either saturated (especially in the case of the former business trinity) or are going to be saturated in the near future (the case of the firms). They sell a similar product, to many buyers and sellers who are well informed about the demand and supply situations of these firms.
Why then is this an issue if the resulting condition is good for the consumer who will benefit from low prices and bad for the seller who will have to make do with zero profits? It is obviously a good thing for the consumer as he will have cheap stuff. He/she will be able to buy cheap clothes, get a cheap phone, access cheap internet and even have someone do his books for him at a low price. The concern in this article is not for the consumer, it is for the firm and the economy at large.
Low profits will add little value to the economy as in the long run, firms will have no incentives to hire new workers and expand their activities. They will pay less in taxes and therefore add little revenue to the taxpayer. There will then be little income for the government to achieve infrastructure expansion and carry out their mandate.
Furthermore, for me it reflects a failure of our educational system. The clear lack of a stimulating and empowering educational system has two effects. A narrow skill base from which more diverse business ideas can emerge and a monkey see monkey do business climate. The country's business environment needs clear innovation or otherwise many of the existing businesses will have to make do with penny pinching from meagre earnings adding no enterprise value to the economy. Imagine one wanted to buy the businesses; the small earnings will lead to low valuations from potential investors as future earnings are limited. Most business valuations are contingent upon valuing future cash flows so as to get a present value of the business. The businessmen in the businesses and firms therefore lose in their investments from both an earnings perspective as well as an asset growth perspective.
We need more innovation through I suggest better education so that we can have a robust business climate within the country.