The prospect of being included in the supply chain of major JSE-listed and multinational corporations has given a glimmer of hope to many small and medium-sized entrepreneurs. Many encounter fierce competition from established corporates armed with enormous war chests and often stand no chance in getting a foot in the door of cut-throat industries that have, until now, been ring fenced by legacy suppliers who have monopolised supply chains for decades.
Andile Khumalo CEO, KhumaloCO
Preferential Procurement and Enterprise and Supplier Development (ESD) has long been seen as a powerful tool to transform the economy.
The Sanlam Transformation Gauge, one of the foremost surveys that studies black economic empowerment, echoes these disturbing findings by the B-BBEE Commission. The survey also found that ESD is one of the worst performing B-BBEE indices, alongside management control.
The disappointing performance of ESD is cause for concern due to the inherent benefits that the beneficiaries of ESD and the economy can derive if there is a well-thought-out and proper strategy in place.
The rationale is that if you can incentivise corporate South Africa to procure from black-owned businesses, you create access to a market that is often controlled by a few insiders. Many black entrepreneurs had resigned themselves to the notion that the preferred supply chain to these entities is the preserve of an exclusive boys’ club – and they were not necessarily wrong.
At the launch of the 2023 Sanlam Transformation Gauge, Litha Kutta, the Co-Chair of the recently launched Enterprise and Supplier Development Community of Practice, referred to this fact when he mentioned that he can often tell the racial and gender profile of the supply chain by simply looking at the racial and gender profile of the people who run a company’s procurement department.
If you marry that anecdote with the latest numbers from the Commission for Employment Equity, you can see where some of the problems may lie. The commission’s report finds that “white people continue to dominate top management positions at 62.9%, followed by 16.9% black people, 11.2% Indians, 6.1% coloured people and 3% foreign nationals”. Males still occupy 73.5% of these top-level positions.
So, in short, we are asking mostly white male decision makers to break their habits of buying from the same ‘trusted’ suppliers they have been using for years, and start casting their net wider by procuring from black businesses that have traditionally lingered outside of their supply chains. How do we get this right? How do we ensure that legislation facilitates this shift in a sustainable way?
“The rationale is that if you can incentivise corporate South Africa to procure from black owned businesses, you create access to a market that is often controlled by a few insiders.”
According to the B-BBEE Commission, the purpose of ESD is “to promote a conducive environment for creation of sustainable partnerships between corporate South Africa and black entrepreneurs to enable access and transformation of the value chains.”
In other words, the aim of ESD was to increase the participation of black-owned SMEs within both the public sector’s supply chain and in the wider economy, with a view to scale up and sustain these entrepreneurs.
According to the ESD element of the B-BBEE generic scorecard, the measured entity is required to achieve a 40% sub-minimum on the total points allocated for preferential procurement, supplier development and enterprise development. This means that for a measured entity not to drop a level on its overall B-BBEE status, it will need to score at least 10 points for preferential procurement, four points for supplier development and two points for enterprise development.
Disclose the rands
In the scorecard, the ESD element is reported as one line, showing the target points and the achieved points. I think this should be reconsidered. I think it would be very helpful to see the actual numbers for preferential procurement expressed in rands spent with businesses that are at least 51% black-owned by a measured entity. This will go a long way in showcasing the actual value of transactions that took place as opposed to simply points scored.
Don’t keep the small, small on another matter, the current generic B-BBEE codes incentivise companies to spend with small black-owned companies. As these companies grow and scale, the incentive reduces, driving companies to replace them with other smaller black suppliers. This may have the unintended consequence of stunting the growth potential of black businesses.
Karabo Mashugane, the CEO of 20/20 Insight – specialists in B-BBEE advisory, supplier development and SME financing-explained it best in a recent article.
“In the amended B-BBEE Codes, small businesses were split into two categories to ensure the codes really had a broad-based reach. SMEs with annual turnover below R10m were categorised as Exempt Micro Enterprises (EMEs), and those between R10m and R50m labelled as Qualifying Small Enterprises (QSEs).
“Unfortunately, those who succeeded were faced with a dilemma. The SMEs which they developed and gave market opportunities that might grow turnover beyond the stipulated categories. If that happened, the corporate would not be able to claim the B-BBEE points they sought in that category. For example, issuing an EME with a contract for R20m per annum increases the EME’s turnover above the R10m threshold. When this happens, the corporate can no longer claim BEE points on that procurement spend in the EME category. It thus risks noncompliance despite acting in the true spirit of B-BBEE. The result is that, to maximise B-BBEE compliance, corporates should avoid developing SMEs or issuing them with large contracts even when it is feasible,” says Mashugane.
Spend the money and spend it wisely
The B-BBEE Act explicitly set the targeted ESD spend of 3% net profit after tax (NPAT). A recent study by the B-BBEE Commission found that the quantum of resources available for ESD is quite significant, with nearly R26bn allocated to ESD spend. My personal view is that it’s probably twice that amount.
In any event, the B-BBEE Commission’s study states that only 61% of the funds allocated to ESD were actually implemented, which is a continuing trend over the past five years (2017: 44%; 2018: 60%; 2019: 51%; 2020: 61%).
More worryingly, a study conducted by Creative Value Creations found that only 16% of black-owned companies had access to ESD spend.
So it seems we not only have an issue with spending the funds, but we also have an issue with spending the funds well. How else would we explain the reported lack of impact that B-BBEE is having on black-owned small business, notwithstanding the billions being spent?
Measure continuous benefits Columnist Lusapho Njenge captured another regulatory challenge quite eloquently when he wrote: “The ESD element requires significant effort each year to ensure that a measured entity achieves its annual transformation objectives. This is because grants are recognised once off and loans are recognised on the outstanding loan balance at the end of the period of assessment (typically a 12-month financial year), even though the beneficiary continues to benefit from the support beyond the assessment period.
This is not the case with elements such as ownership and management control, where an organisation continues to benefit from efforts of previous years for as long as the levels of ownership and management control are maintained.”
Njenge raises a valid point that definitely needs a look into, if we want to drive the right behaviour. My overall contention is that we should renew our focus on the efficacy of ESD and measure its outcomes, instead of being blindsided by points scored. By failing to measure the outcomes of ESD, we are missing a golden opportunity of stimulating economic growth and giving black-owned businesses an opportunity to thrive and create much needed employment opportunities.
By design ESD can have immensely positive multiplier effects on the domestic economy. When corporates procure goods and services from small and medium sized companies, it has positive ripple social and economic benefits for the local communities as it stimulates the local economy, helps to attract investment and creates much-needed jobs.
Despite the obvious importance of ESD, the B-BBEE Commission’s report found that only 62% of companies have ESD strategies. This indicates that companies are simply targeting spend and not impact. You only need a strategy if you want to have a specific output, but if all you need is to spend, why have a strategy? The lack of one informs the attitude most companies have.
The blame for focusing on spend rather than impact lies squarely on the doorstep of policy makers. This is a mistake that needs to be rectified. We need a fundamental change in the generic codes and all sector codes on defining critical success factors for ESD and how it is measured.
If ESD is more strategically implemented, it can foster the sustainability of black owned enterprises and contribute meaningfully to enhance their skills and innovation capacity, which will bode well for their ability to create decent jobs.
The B-BBEE Commission’s research study on ESD carries some recommendations. One of them is that ESD funds should be pooled into a central fund managed by the state in order to revitalise ESD and improve its impact.
This is a terrible idea. Government’s track record in managing public finances is not exactly stellar, and successive reports by the Auditor-General attest to this fact. The state does not have the social capital nor the capacity to manage these funds, and moreover, public trust in state institutions in managing money has been eroded.
The country is still reeling from the findings of the Zondo Commission on State Capture, and to borrow the colloquialism, it’s too soon to entrust the state with such vast amounts of private capital. In all honesty, vesting these resources under the care of the state would further spook private companies and haemorrhage any vestiges of goodwill left.
ESD is too important to fail I cannot over emphasise the extent to which getting the policy and regulatory framework right will spur the growth of small and medium-sized businesses and will help stimulate economic growth and job creation.
Throwing money at the problem will not miraculously improve the fortunes of SMEs in South Africa. The policy and regulatory environment adversely impacts on the lifespan and scalability of SMEs and start-ups in South Africa, with some studies showing that more than 75% of businesses fail in the first five years.
We regularly hear how SMMEs are the engine of economic growth and the role they can play in ameliorating unemployment in South Africa. However, the policy and regulatory environment stifles their growth and stunts them from reaching their true potential as major players in the mainstream economy.
According to the Organisation for Economic Co-operation and Development (OECD), small businesses in South Africa contribute approximately 40% to GDP. This is dismally short of the 90% contributed by their counterparts in other developing countries, according to the World Bank.
The World Bank says SMEs also account for the majority of businesses worldwide and are important contributors to job creation and global economic development. They represent more than 50% of employment worldwide.
What we need more than anything else in South Africa is sustainable economic opportunity for the many unemployed young people who finish school every year. That is either in the form of finding jobs (being an employee) or starting and running businesses (being an employer). ESD is critical for us to achieve both.
