World Development Vol. 37, No. 9, pp.

14531464, 2009
2009 Elsevier Ltd. All rights reserved
0305-750X/$ - see front matter
www.elsevier.com/locate/worlddev
doi:10.1016/j.worlddev.2009.01.013

Small Firm Growth in Developing Countries

SIMEON NICHTER
University of California, Berkeley, CA, USA

and

LARA GOLDMARK *
Development Alternatives, Inc., Rabat, Morocco
Summary. Although the vast majority of small rms in developing countries never expand beyond a few employees, some experience
rapid and substantial growth. This study explores factors associated with small rm growth. We discuss key ndings for four types of
factors: (1) individual entrepreneur characteristics; (2) rm characteristics; (3) relational factors (such as social networks or value chains);
and (4) contextual factors (such as the business environment). We conclude by suggesting implications for development practitioners.
2009 Elsevier Ltd. All rights reserved.

Key words microenterprise, small rm, entrepreneur, growth, value chains, business environment

1. INTRODUCTION and drive aggregate employment growth in the small business

What explains small rm growth? Many commonly held be-
liefs about small rm growth are shaped by well-publicized
stories about a few extraordinarily successful entrepreneurs.
According to these stories, rm growth is propelled by the al-
most single-handed eorts of a dynamic, hardworking entre-
preneur (usually male) who slaves around the clock for years
in his garageuntil one day, the big break comes. At this
point, some combination of investors and customers recognize
the value of the entrepreneurs unique product idea and
poof, the edgling business expands rapidly and becomes
a household brand name.
The truth is that we know very little about micro and small
enterprise (MSE) growth. Research suggests that even in the
United States, high-growth companies rarely begin with a win-
ning product idea that catapults the lone entrepreneur from
garage to swanky boardroom (Collins & Porras, 1994;
Ormerod, 2005). And if the above scenario is unlikely when
the garage in question is located in Palo Alto, California, it
becomes downright implausible if the start-up is based in a place
such as La Paz, Bolivia; Nairobi, Kenya; or Dhaka, Bangladesh.
Despite the creativity and diligence of many developing-
country entrepreneurs, few of their rms will ever experience
substantial growth. Surveys of over 28,000 micro and small
enterprises in Africa and Latin America reveal that less than
3% of MSEs expand by four or more employees after start-
up (Liedholm, 2002; Mead & Liedholm, 1998). Another rigor-
ous study in Mexico nds that in a given year, just 12% of
owner-only rms expand, and that larger microenterprises
have a higher probability of contracting than expanding
(Fajnzylber, Maloney, & Rojas, 2006).
Yet aggregate MSE growth reveals a remarkably dierent
picture. For example, the survey of 28,000 MSEs in Africa
and Latin America suggests aggregate employment growth
within the sector of nearly 17% per year, at least double the
GDP growth rate in most countries studied (Mead &
Liedholm, 1998). This impressive growth is typically fueled
by a narrow group of high performance rms. These rms,
known as gazelles in the United States literature (Birch,
1987; Boston & Boston, 2007), vastly outperform their peers
1453
sector. Why do some MSEs expand rapidly while others stag-
nate?
To explore this important question, we investigate factors
associated with MSE growth. First, we briey discuss the over-
all importance of MSEs and our research methodology. Then,
we explore numerous factors associated with small rm
growth. We discuss key ndings for four types of factors: (1)
individual entrepreneur characteristics; (2) rm characteristics;
(3) relational factors (such as social networks or value chains);
and (4) contextual factors (such as the business environment).
While this study focuses primarily on developing countries, we
also draw some comparisons with ndings from developed
countries. We conclude by drawing implications for MSE
development practitioners.
2. THE ROLE OF MICRO AND SMALL ENTERPRISES
Following previous studies, we dene MSEs as rms with
up to 50 workers that engage in non-primary activities and sell
at least half of their output. In both developing and developed
countries, the vast majority of rms are MSEs. For example,
approximately 97% of rms in Mexico and Thailand are
MSEs (Kantis, Angelli, & Koenig, 2004; Simmons, 2004). In
the United States, over 96% of businesses similarly have fewer
than 50 employees (US Small Business Administration and
Census Bureau, 2006). Ocial statistics frequently underesti-
mate the number of micro and small enterprises, leading some
* This article is based in part on research conducted by the authors for the
USAID Accelerated Microenterprise Advancement Project. The authors
thank the following individuals for providing insight during interviews:
Thorsten Beck, Albert Berry, Ronald Cooper, Gustavo Crespi, Antonie de
Wilde, Brian Headde, Hugo Kantis, Juan Jose Llisterri, Donald Mead,
Reshmi Mitra, and Carlos Moreno. They also thank Marguerite Berger,
Jeanne Downing, Elizabeth Dunn, Maysa Eissa, and Zan Northrip for
guidance and advice. Simeon Nichter acknowledges support of the
National Science Foundation. Final revision accepted: January 27, 2009.
1454 WORLD DEVELOPMENT
researchers to argue that actual gures may be twice as high as
what is reported (Mead & Liedholm, 1998).
The MSE sector generates substantial employment and eco-
nomic output in many countries. Their share of overall
employment tends to be higher in developing countries, which
are typically more focused on small-scale production (Tybout,
2000). Studies in ve African countries (Botswana, Kenya,
Malawi, Swaziland, and Zimbabwe) found that MSEs gener-
ate nearly twice the level of employment that registered,
large-scale enterprises and the public sector do (Mead & Lied-
holm, 1998). In many Latin American countries, micro and
small enterprises employ over half the working population.
An ILO study (2003) examining rms with fewer than 10
workers found that they generated 58% of total employment
in Paraguay, 54% in Mexico, and 53% in Bolivia. With respect
to economic output, the contribution of the MSE sector varies
considerably across countries. MSEs contribute approxi-
mately 31% of overall GDP in the Dominican Republic,
13% in Kenya, and 11% in Pakistan (Daniels, 1999; IDB,
1998; Small, 2002). Ocial statistics may underestimate
MSEs contribution to GDPfor example, some experts ar-
gue that Kenyan MSEs actually generate 40% of GDP, not
13% (Daniels, 1999; Gamser, 2003).
3. RESEARCH METHODOLOGY
This study builds on a comprehensive survey of the litera-
ture on small rm growth. Based on this secondary research,
we provide a synthesis of numerous factors associated with
MSE growth, draw parallels between ndings in developing
and developed countries, and discuss implications for develop-
ment practitioners. We identied key publications using a sys-
tematic methodology. 1 Most of the studies cited in the present
article have been published in peer-reviewed academic jour-
nals. Before citing studies, we assessed the rigor of their quan-
titative and qualitative analyses, particularly in the case of
non-peer-reviewed publications. For example, we considered
the extent to which econometric studies address such issues
as endogeneity, omitted variables bias and selection eects.
With respect to qualitative studies, we examined aspects such
as the number of respondents and sampling techniques em-
ployed. In this article, we explicitly identify studies that are
particularly rigorous or employ exceptionally large sample
sizes. To complement our comprehensive survey of articles,
books, and working papers, we conducted interviews with
numerous academics and practitioners recognized for their
expertise in the eld of small enterprise development. 2 These
interviews enabled us to explore emerging hypotheses, to clar-
ify nuances about topics with inconclusive or controversial
data, and to identify themes for additional research.
The present article examines a wide range of studies consid-
ering heterogeneous contexts and samples. This breadth pro-
vides many insights, but it also requires caution.
Generalizations can be misleading; they should be questioned
and re-examined in each country and market context. Some
factors that inuence growth, such as a rms age, are rela-
tively simple to dene and measure. Others are more complex,
such as the characteristics of value chains in which small rms
operate. We do not claim to provide an exhaustive review of
all factors linked to MSE growth. Instead, we oer an over-
view of key factors in the literature on MSE growth in devel-
oping countries.
This article denes rm growth as an increase in the number
of employees over time. The majority of studies on small rm
growth employ this metric, although some scholars (especially
those focused on developed countries) use alternative metrics
such as revenue or asset growth. The vast majority of research-
ers studying small rm growth in developing countries rely on
employment growth because it is often extremely dicult to
obtain reliable nancial data for small rms (e.g., Bigsten &
Gebreeyesus, 2007; Mead & Liedholm, 1998; Robson &
Obeng, 2008). Even when MSE owners do not keep written re-
cords, they can usually recall their number of employees over
time.
4. INDIVIDUAL ENTREPRENEUR
CHARACTERISTICS
We now discuss individual entrepreneur characteristics for
which there is signicant empirical evidence from developing
countries: education, work experience, and gender. Numerous
growth factors examined in the developed country literature
are understudied in developing countries. For this reason,
we do not include below factors such as entrepreneurial moti-
vation (e.g., linked to small rm growth in Sweden by Delmar
and Wiklund (2008)) and entrepreneurial team composition
(e.g., linked to small rm growth in Italy by Colombo and
Grilli (2005)).
(a) Education
Intuitively, one might expect higher levels of formal educa-
tion to spur MSE growth by enhancing rm capabilities. For
example, formal education may provide entrepreneurs with a
greater capacity to learn about new production processes
and product designs, oer specic technical knowledge condu-
cive to rm expansion, and increase owners exibility. While
most empirical evidence indeed suggests that rms with better-
educated owners and managers are more ecient (e.g., Burki
& Terrell, 1998; Tan & Batra, 1995), greater complexity
emerges when one examines the relationship between educa-
tion and MSE growth in developing countries.
Developing-country MSE owners and workers often have
relatively low levels of education. One reason is that despite re-
cent advances, primary education completion rates remain at
only 60% in Sub-Saharan Africa, 80% in South Asia, and
90% in the Middle East and North Africa (World Bank,
2009). In addition, MSEs tend to have less-educated owners
and workers than do larger rms (Orlando & Pollack, 2000;
Soderbom & Teal, 2001). Educational disparities across rm
size are especially striking at the university level: for example,
21% of microenterprise owners in Chile have Bachelors de-
grees, compared to 42% of small rm and 55% of medium-rm
owners (Alvarez & Crespi, 2003). The lower level of educa-
tional attainment among MSE owners and workers is remark-
able when contrasted with the situation in developed
countries, where those with higher education are more likely
to be self-employed (Woodru, 1999). One reason for this con-
trast is that the poor in developing countries often create sur-
vival-oriented MSEs due to a lack of alternative employment
opportunities.
Given the relatively low level of education within the MSE
sector in developing countries, do MSEs with more highly
educated owners tend to grow more quickly? On the surface,
the evidence appears contradictory. For example, an Inter-
American Development Bank (IDB) study found that second-
ary school attainment had no discernible impact on rm
growth in Latin America (Kantis et al., 2004). On the other
hand, numerous studies in Sub-Saharan Africa suggest that
entrepreneurs completing secondary school have more rapidly
 SMALL FIRM GROWTH IN DEVELOPING COUNTRIES
growing rms in Kenya and Zimbabwe, but these same studies
nd no signicant eect of primary education on MSE expan-
sion (McPherson, 1991; Mead & Liedholm, 1998; Parker,
1995).
Some clarity emerges when we recognize the threshold ef-
fect of education. 3 MSEs with more highly educated owners
tend to grow more quickly, but a country-specic threshold
must be reached to observe this growth eect. For example,
whereas the threshold represented by secondary education
may identify high-growth potential in the African countries
just mentioned, a higher threshold of university education
appears to exist in Latin America. Although the IDB study
found that secondary school attainment has no eect on
MSE growth, it also reveals that six of every 10 Latin Amer-
ican entrepreneurs with high-growth rms are university
graduates (Kantis et al., 2004).
Despite various potential benets, education may also harm
MSE performance if owners divert their attention to other
attractive business opportunities. Research on small manufac-
turing rms in Chile found that university education did not
induce higher eciency. Some highly educated owners paid lit-
tle attention to monitoring their labor force, in part because
they were distracted by other activities (Alvarez & Crespi,
2003).
(b) Work experience
Small business owners often learn on the job. Work experi-
ence may contribute to MSE growth in at least two ways: di-
rectly, by expanding the capabilities of MSE owners and
employees through the acquisition of skills and knowledge;
and indirectly, by expanding entrepreneurs social networks.
Entrepreneurs with more years of work experience typically
have faster-growing MSEs. For example, one study found that
Kenyan entrepreneurs with at least 7 years of work experience
expanded their rms more rapidly than those without such
experience did (Parker, 1995).
While the benets of on-the-job experience are frequently
mentioned, the importance of prior work experience may be
even more helpful, especially if that experience occurred within
the same sector or in small-to-medium-sized enterprises. An
IDB study of high-growth entrepreneurs provides telling in-
sights about the importance not only of skills but also of busi-
ness contacts gained during past employment (Kantis et al.,
2004). Among Latin American and East Asian entrepreneurs,
contacts were found to be a key benet of work experience,
helpful in identifying business opportunities, obtaining nanc-
ing and other resources, and alleviating management chal-
lenges.
Unfortunately, some developing regions are characterized
by a systematic lack of opportunities for relevant work expe-
rience. In particular, Africa has few medium-sized companies
where entrepreneurs can gain work experience, a phenomenon
known as the missing middle. For this and other reasons,
MSE owners and workers in Ghana have an average of only
5 years of work experience, compared to 10 years for their
counterparts in larger rms (Barr, 1998).
Within developed countries, there is mixed evidence linking
prior sector experience to small rm growth. Numerous stud-
ies nd a nonexistent or even a negative relationship between
work experience and growth (Cooper, 1993; Storey, 1994). For
example, Storey (1994) suggests that if any pattern emerges, it
is the association of longer work experience in a sector with
slower rm growth. On the other hand, a more recent panel
survey of 1,000 entrepreneurs in the Netherlands found that
entrepreneurs prior experience, when in the same industry
1455
as their start-ups, improves rm growth, survival, and prot-
ability (Bosma, van Praag, Thurik, & de Wit, 2004).
(c) Gender and household
Women own and operate the majority of MSEs in many
developing countries, in part because of the ease of entry
and their limited access to alternate opportunities (Rubio,
1991). Studies across nine countries in Africa and Latin Amer-
ica found that on average, 61% of MSEs are owned by women,
ranging from 46% in Malawi, Kenya and the Dominican
Republic to 84% in Swaziland (Mead & Liedholm, 1998).
Yet women often face particularly dicult challenges that sup-
press the growth of their rms. In some cases, women may also
choose not to grow their rms.
The developing-country literature identies numerous gen-
der-related challenges to MSE growth. Women typically face
asymmetrical rights and obligations limiting their labor mobil-
ity and burdening them with disproportionate household
responsibilities (Downing & Daniels, 1992). One econometric
study based on Guatemalan data suggests that the high mar-
ginal value of home time for women during certain periods
of their lives is the principal constraint to the growth of fe-
male-owned rms (Kevane & Wydick, 2001). In some coun-
tries, women face relatively greater problems with
innumeracy, illiteracy, and a lack of business skills (ILO,
1999). In addition, women commonly have unequal access to
markets. For example, research in Gujarat, India found that
36% of female entrepreneurs sell to purchasers who come di-
rectly to their homes, compared to 20% of their male counter-
parts (Kantor, 2005). As a result of such factors, women also
frequently focus their MSEs on a relatively narrow range of
industries.
At the same time, women-owned MSEs often play a crucial
role in increasing and diversifying household incomes. Women
may operate MSEs with small but regular contributions to in-
come, thus facilitating their husbands entrepreneurial aspira-
tions. Following such survival strategies, women may strive to
grow laterally; instead of specializing in their MSEs industry,
by expanding them in size, they may opt to diversify by creat-
ing additional rms (Downing & Daniels, 1992).
What consequences do the challenges and strategies men-
tioned above imply for MSE growth? Empirical evidence sug-
gests that womens MSEs tend to grow more slowly than
those owned by men. For example, Mead and Liedholm
(1998) found that employment in male-headed MSEs grows
an average of 11% a year, versus 7% for female-headed MSEs.
This dierence in growth rates is partially due to the location of
womens MSEs in slow-growing sectors, but a statistically sig-
nicant dierence remains even when controlling for sector.
Similarly, IDB research in Latin America and Asia found that
only one in 10 rms growing to at least 15 employees is woman
owned (Kantis et al., 2004). One contributing factor to the
slower growth of female-owned MSEs is the high probability
that they are physically located within the household. An
ILO statistical report (2004) indicates that 80% or more of
homeworkers (dened as industrial outworkers who work
at home) in developing countries are women. Household rms
are not only signicantly smaller on average, but also they are
less likely to grow than other MSEs (Mead & Liedholm, 1998).
Despite the growth constraints discussed in this section, wo-
men are often highly eective rm owners. For instance, a
study in the Dominican Republic found that female-owned
textile MSEs have higher levels of labor productivity than
those owned by men, even though they experience slower
growth (cf. Downing & Daniels, 1992). Women-owned MSEs
1456 WORLD DEVELOPMENT
have also been found to have closure rates for business reasons
comparable to those of rms owned by men (Mead &
Liedholm, 1998).
In the developed country literature on small rm growth,
most studies do not nd gender to be signicantly associated
with rm growth; those that do are in disagreement about
whether women-owned rms are likely to grow faster or
slower (Storey, 1994). One qualitative study that set out to
identify gender-based dierences among rural microenterpris-
es in Sweden concluded: The actual nding was that there are
few dierences (Sandberg, 2003). Although the developed
country literature often construes women entrepreneurs as less
likely than their male counterparts to seek rm growth, several
researchers argue that this applies only to a subset of women-
owned rms (Chaston, 2008; Harada, 2007; Hill, Leitch, &
Harrison, 2006). As is true for other factors, categorizing
MSEs only as female-versus male-owned rms may generate
an impression of false universalism that ignores the hetero-
geneity of small rms (Marlow & Patton, 2005).
5. FIRM CHARACTERISTICS
Certain rm characteristics are associated with MSE
growth. This section explores the relationship between MSE
growth and three widely studied rm-level factors in the devel-
oping-country literature: rm age, formality (or informality),
and access to nance. Other factors, such as technology, loca-
tion, and sector, are discussed only to the extent that they re-
late to these three variables.
(a) Firm age
The relationship between rm age and small rm growth in
developing countries is particularly robust. Young MSEs grow
substantially more rapidly on average than their older coun-
terparts do. Studies in both Africa and Latin America show
that young MSEs are more likely to show high rates of growth
compared with MSEs that have been in existence longer
(Mead & Liedholm, 1998; Parker, 1995). An IDB study reveals
that the major expansion of dynamic enterprises occurs during
their third year of operation (Kantis et al., 2004), and other
studies suggest that the average growth rate of rms decreases
with age (e.g., Burki & Terrell, 1998).
Why might young MSEs grow more quickly than older
MSEs? A seminal theoretical paper by Jovanovic (1982) oers
one possible explanation. Jovanovic proposes a learning mod-
el in which a rm expands quickly at rst, and then tapers o
its growth as it approaches its optimal size. Although growth
slows, productivity is expected to increase as the rm ages and
the owner comes to learn the companys optimal size of oper-
ations. On the other hand, some studies in developing coun-
tries suggest that rms actually suer productivity losses as
they become older (Burki & Terrell, 1998). Firms may fail to
invest suciently in existing or emerging technology, leaving
them with relatively outmoded equipment and hindering pro-
ductivity levels relative to those of younger rms.
In reality, a rms growth rate is likely to uctuate as it has
both positive (learning-by-doing, increases in productivity)
and negative (crises, decreases in productivity) experiences
during its lifetime. Recognizing that the relationship between
rm age and growth may be more complex, several researchers
have developed frameworks based on a life-cycle approach:
(1) Churchill and Lewiss (1983) model breaks the growth
continuum into stages of development. At each stage in a
rms life, dierent factors become important, such as
owner objectives, managerial skills, and access to capital,
technology, and human resources.
(2) Several typologies (e.g., Mitra, 2002; Mitra & Pingali,
1999) highlight issues specic to family or women-owned
rms, such as the strong identication of individuals with
their business, the establishment of a balance between fam-
ily and business concerns, and the link between an entrepre-
neurs source of motivation and the growth trajectory of
her rm.
(3) Another approach identies dominant types of crises
that small rms face and links solutions to these problems
with dierent growth stages. Examples are starting and
cash crises, delegation and leadership crises, nance and
prosperity crises, and succession crises (Patel, 1995).
Researchers who work on developed country MSEs have
also explored the relationship between rm age and growth.
Most studies nd that older rms experience less growth
(e.g., Evans, 1987; Heshmati, 2001; Variyam & Kraybill,
1992), as consistent with the developing-country literature.
Some studies report mixed results. For example, Heshmati
(2001) nds that while younger rms experience faster employ-
ment growth in Sweden, older rms experience faster growth
in assets and sales. Within the developed country literature,
researchers often pay close attention to the eect of rm size
as well as that of rm age. In the 1980s, a debate emerged sur-
rounding Gibrats Law, which posits that rm growth is inde-
pendent of size. Contrary to this theory, numerous empirical
studies nd that smaller rms in developed countries in fact
grow more quickly (e.g., Evans, 1987; Hall, 1987; Variyam
& Kraybill, 1992).
(b) Formality (or Informality)
Informality is common in developing countries. The ILO
(2004) reports that the informal economys share of the non-
agricultural workforce has reached 55% in Latin America,
4585% in Asia, and nearly 80% in Africa. For the purposes
of this paper, informality refers to businesses that are unregis-
tered but derive income from the production of legal goods
and services. 4 In terms of sheer quantity, the number of infor-
mal rms often dwarfs the number of ocially registered
enterprises. Not only does informality in itself reduce the
chances for growth, but also it is associated with several other
characteristics that make growth dicult.
Although small, informal MSEs may be able to circumvent
government regulations and taxation, as they grow they risk
becoming more visible, creating disincentives to expand be-
yond a certain size (Snodgrass & Biggs, 1996). Informal rms
may therefore need to keep their heads down, ruling out
large size and rapid growth as well as close relations with for-
mal rms (Winter, 1995). Contracts with international or gov-
ernment buyers, for example, may be o-limits for many
informal rms because they require legal documentation that
these MSEs lack. And while many rms in developing coun-
tries have problems accessing nancial and legal systems,
informal enterprises face even greater diculties in obtaining
formal credit and assistance from law enforcement agencies
and courts.
For these and other reasons, informal MSEs tend to grow
more slowly than do their formal counterparts. An economet-
ric study in Cote dIvoire found that formal status has a posi-
tive eect on rm growth, even when using instrumental
variables and controlling for the size, age, and eciency of
rms (Sleuwaegen & Goedhuys, 2002). Analysts at McKinsey
and Co. argue that informal companies tend to be subscale,
subinvested, and subskilled, and that they also tend to produce
 SMALL FIRM GROWTH IN DEVELOPING COUNTRIES
substandard products and services (Capp, Elstrold, & Jones,
2005). While such an assessment may be overly pessimistic,
the Cote dIvoire study suggests that formal rms are more
ecient for two reasons: they enjoy a larger range of produc-
tion factors and they have a broader range of choices when it
comes to input suppliers (Sleuwaegen & Goedhuys, 2002).
Certain MSE characteristics make it particularly likely that
they will operate in the informal economy, a point under-
scored by McPherson and Liedholms (1996) empirical re-
search into African countries with divergent policy and
regulatory environments. They found that the likelihood of
registration did not depend on country. Rather, certain types
of MSEs are less likely, ceteris paribus, to be registeredown-
er-only rms, and those that are rural, owned by women, oper-
ated within the household, or located in certain sectors.
(c) Access to nance
For various reasons ranging from a lack of collateral to bias
against small rms, MSEs tend to face greater nancial con-
straints than do larger rms. An IFC study of 10,000 rms
across 80 countries found that credit is mentioned more fre-
quently by smaller rms as a constraint on growth (Schier
& Weder, 2001). MSEs in developing countries apply for
and receive formal bank loans relatively infrequently; they
thus typically rely on other types of credit such as trade credit,
overdrafts, and informal loans (Bigsten et al., 2003). Micro-
nance institutions also provide important sources of nancing
for MSEs, but their outreach is typically more limited than
that of traders who frequently provide working capital in cash
or kind, especially in rural areas (Swinnen, 2005).
Because of limited access to capital, entrepreneurs across the
world typically start rms primarily through their own savings
(Mason, 1998). For example, a study of over 14,000 microen-
terprises in Mexico found that owners mostly used their own
resources and savings (61%) or those of their family and
friends (14%) to launch their rms (Hernandez-Trillo, Pagan,
& Paxton, 2005). Developed country researchers have identi-
ed similar trends, including a range of creative mechanisms
used by small rms to leverage tangible and intangible assets,
known as bootstrapping (Lahm & Little, 2005; Neeley,
2003).
Even after MSEs overcome the start-up hurdle, a lack of
credit frequently hinders their growth during their early years,
as younger rms tend to nd nancing even more dicult than it dicult for outsiders to gain entrepreneurial opportunities.
older rms do (Schier & Weder, 2001). Over the life of the
rm, growth can also be hindered by credit constraints that
curb investments in the maintenance or improvement of tech-
nology. In some contexts, evidence suggests that microenter-
prises funded through external sources (e.g., bank loans and
credit from buyers or suppliers) are more ecient, but it re-
mains unclear whether this nding simply reects ex ante
screening by selective creditors (Hernandez-Trillo et al., 2005).
Although many MSEs have limited access to capital, it is of-
ten unclear whether credit represents a binding constraint on
rm growth. Few empirical studies have explicitly tested the
positive link between access to nance and MSE growth.
The ndings from one econometric study, based on a random
sample of 225 MSEs producing garments in Nairobi, Kenya,
suggests that further research is needed (Akoten, Sawada, &
Otsuka, 2006). The authors argue that credit access is not a
signicant determinant of rm performance, and that the fac-
tors signicantly aecting credit access are dierent from those
aecting the growth and protability of garment rms. As
development nance practitioners have long preached, a loan
does not create a viable business opportunity. Like many of
1457
the factors discussed in this article, access to nance may be
necessary but it is not a sucient condition for MSE growth.
6. SOCIAL NETWORKS
This section explores the relationship between social networks
and MSE growth. The term social networks is used here to re-
fer to relationships between individuals. 5 Having an extensive
social network is a valuable asset that can help an entrepreneur
obtain access to information (e.g., leads about protable busi-
ness opportunities) as well as resources (e.g., credit).
While social networks can enhance MSE growth in any con-
text, they can be critical to rms growth prospects in environ-
ments with pervasive market failures. The literature points to
the role social networks can play in helping entrepreneurs
overcome obstacles related to transaction costs, contract
enforcement, and regulation. Examples include buyerseller
bargaining with acquaintances in Moroccos bazaar economy
(Geertz, 1978); the overwhelming preference of Ghanaian
rms for doing business with individuals they already know
(Fafchamps, 2000); Jewish diamond merchants in New York
lending gems to each other overnight for inspection without
contracts to avoid lawyer fees (Portes & Landolt, 1996); and
MSE owners turning to experienced neighbors for help in reg-
istering a new business. Entrepreneurs often take advantage of
opportunities to invest in social networks when there is an
apparent payo to be anticipated in terms of MSE growth.
For example, a family may opt to perform specic ceremonies
when planting cocoa because it will later depend on additional
labor and resources from others within the social network
(Berry, 1993). Quantitative studies conrm the importance
of social networksfor example, an econometric study of
small-scale manufacturing in Ghana found that entrepreneurs
with larger and more diverse sets of networks are more pro-
ductive (Barr, 1998). Connections across dierent groups
may enhance mobility and be especially useful for MSEs try-
ing to overcome regulatory or other obstacles.
Social networks also have numerous potential downsides for
MSE growth. In some cases, social networks may be too
expensive for or inaccessible to the poorest entrepreneurs, or
may systematically exclude or provide unequal access to re-
sources for marginalized entrepreneurs such as women. Social
networks may be deeply rooted in societal traditions, making
Other potential downsides of social networks include requests
for prot distributions, unequal access to resources, and a lack
of stability. For example, research in Bali showed that social
networks can actually serve to hinder economic production,
as social claimants preferred prot distributions instead of
the reinvestment necessary for growth (Geertz, 1978). Finally,
the sustainability of social networks is also an issue. If a net-
work grows, its greater number of participants oers increased
resources for MSEs, but the networks usefulness may also de-
cline as it becomes more inclusive. This reason is, in part, why
immigrant groups often spatially self-segregate to avoid over-
loading duties on network members (Luo, 1997).
7. VALUE CHAINS
Value chain characteristics can help us understand whether
and (if so) what types of opportunities for growth are available
to small rms. A value chain, which is narrower than a sector,
traces the ow of competing products from the input stage
to the nal consumer. 6 Agricultural marketing specialists
1458 WORLD DEVELOPMENT
developed this concept in the 1950s and 1960s within the con-
text of commodity systems analysis, which was later termed
sub-sector analysis by development practitioners
(Boomgard, Davies, Haggblade, & Mead, 1992; Goldberg,
1974). In recent years, value chains have been adopted by
researchers writing on business strategy, industrial develop-
ment, and globalization (Humphrey & Schmitz, 2000; Porter,
1998). Within a given value chain, MSEs may be involved in
any number of activities, including primary production,
assembly, and service provision.
An important dimension of growth or potential growth in a
value chain is strong demand from the end market, whether lo-
cal, regional, or international. While an increase in the volume
of goods demanded by the end market may provide opportu-
nities for MSE growth, the type of goods demanded can be
just as important. A sophisticated consumer in local markets
is one of the best indicators for predicting whether develop-
ing-country rmsand by implication, MSEsare likely to
participate in the value-added functions of production. Fair-
banks and Lindsay (1997) refer to the ways in which demand-
ing customers in the home market give international producers
their competitive edge. According to Fairbanks, If you can
sell shoes to an Italian woman, you can sell shoes anywhere
in the world. 7 A similar example is the international success
of Brazilian bikinis (Infomat, 2005). Brazilians possess a large,
diverse, and sophisticated consumer base for bikinis; produc-
ers, both large and small, have turned that to their advantage
when selling in distant markets.
Without demanding local consumers, developing-country
rms, especially MSEs, have a much lesser chance of accessing
the higher margins and value-added functions associated with
the international high-end market segments. MSEs may not
interact directly with developed country rms, but may rather
act as subcontractors to large developing-country manufactur-
ers (Carr & Chen, 2003; Nadvi, 1995). In such cases, the path-
ways to growth may be blocked.
In addition to the nature of demand, there are a number of
sector characteristics that favor the participationand survival
over timeof MSEs. One of the most enduring works on small
enterprise development, by Staley and Morse (1965), identies
ve characteristics of industry functions that bode well for
small rm participation: (1) seasonal activities; (2) low capital
requirements; (3) relative labor-intensiveness; (4) non-repeti-
tive production processes; and (5) small production volumes.
Additional characteristics may be industry or product spe-
cic. In agriculture, for example, specic crop strains may oer
advantages to smallholders, depending on the inputs, land
conditions, and other requirements associated with their culti-
vation. Also important is the organization of the value chain,
especially in terms of inter-rm relationships and power
dynamics. Models described in the literature range from
buyer-driven (top-down and not very conducive to MSE par-
ticipation) chains to producer-driven ones (seen in sophisti-
cated, high-tech chains) to network or non-hierarchical
chains, where power relationships are more balanced (Gere,
Humphrey, & Sturgeon, 2005; Pietrobelli & Rabelloti, 2004).
In sum, the key attributes of value chains linked to MSE
growth include: (1) the nature of demand, (2) sectoral and
industry characteristics, and (3) power relationships.
8. INTER-FIRM COOPERATION
Virtually all rms interact with other rms. This section ex-
plores the relationship between inter-rm cooperation and
MSE growth.
(a) Vertical linkages
Individual rms form vertical linkages with their buyers and
suppliers. Vertical linkages can facilitate MSE growth by
expanding a rms set of viable business opportunities and
by improving rm capabilities. Agreements with buyers can
decrease the risks and costs associated with entering new mar-
kets by providing a guaranteed ow of orders, critical infor-
mation about market requirements, and in some cases, a
reduced need for capital investments (Aw, 2002). Sometimes,
relationships with larger rms can help link rural industries
to urban and international markets. In addition to fostering
growth through expanded business opportunities, vertical
linkages can lead to improved rm capabilities by providing
opportunities for learning and innovationsuch as when cor-
porate buyers assist with quality, maintenance, and technical
issues (Berry, Rodriguez, & Sandee, 2002)or when input
suppliers oer training or information related to the use of im-
proved technologies.
(b) Horizontal linkages
Similar rms may group themselves or be organized by an
outside party to work togetherthese are referred to as hori-
zontal linkages. Among the many legal and organizational op-
tions for institutionalizing horizontal cooperation are
cooperatives, associations, consortia, producer groups, and
other collaborative structures. Horizontal linkages can help
MSEs overcome many of the disadvantages of being small,
providing a way to consolidate production, improve their
negotiating position with buyers or suppliers, access market
information or services, or lobby for political or regulatory
changes (Goldmark & Barber, 2005; Steen, Magnani, &
Goldmark, 2005).
Clusters (geographic and sectoral agglomerations of enter-
prises) may also facilitate MSE growth by enhancing horizon-
tal, as well as vertical, linkages. Clusters inevitably involve
external economies: one rms investments spill over to other
rms in the cluster (Schmitz, 1999). In addition, clusters may
involve consciously pursued joint action, such as the sharing
of machinery or the joint development of a product (Schmitz,
1999). In cases where clustered rms seek to serve the same
market, both competition and cooperation can drive innova-
tion that is critical to rm performance. Of course, the mere
presence of clusters does not guarantee dynamic growth for
MSEs (McCormick, 1999). However, in many cases, participa-
tion in clusters as well as investment in horizontal linkages can
facilitate MSE growth.
(c) Supporting markets
Services provided through supporting marketssuch as -
nance; consulting, legal, and tax advice; market information;
and skills trainingare often directly related to improvements
in capacity. For example, skills training may allow rms to of-
fer new products, while nance may allow them to produce
greater volumes. Access to market information or new tech-
nologies, on the other hand, may help rms seek or respond
to new opportunities. Supporting services may be oered di-
rectly to MSEs on a fee-for-service basis, or they may be
embedded in rm relationships, that is, delivered through ver-
tical or horizontal linkages. While the absence or weakness of
supporting markets is often identied as a constraint on MSE
growth (Field, Hitchins, & Bear, 2000; Gibson, Hitchens, &
Bear, 2001; Lusby & Panlibuton, 2002), it remains uncertain
and widely debated whether the development of supporting
 SMALL FIRM GROWTH IN DEVELOPING COUNTRIES
markets actually stimulates MSE growth. Markets tend to
grow vertically rst, stimulating growth in supporting services
only once there is a critical mass of products owing through
the chain (Steen et al., 2005). As is the case with loans, sup-
porting services are most likely to lead to rm growth in the
presence of viable business opportunities.
9. CONTEXTUAL FACTORS
Contextual factors play a major role in shaping the oppor-
tunities of MSEs in developing countries. Most obviously,
the overall state of the economy directly inuences the avail-
ability of protable business opportunities. Growth opportu-
nities wax and wane as the business cycle evolves. It is
hardly a surprise, then, that MSEs tend to grow more quickly
during periods of overall economic growth (Liedholm, 2002).
There are, however, some important nuances in the relation-
ship between MSE growth in developing countries and the
business cycle: the overall MSE sector often expands during
economic downturns due to an increase in survivalist-type
activities, although individual MSEs may stagnate or contract
(Liedholm, 2002). An econometric study found evidence of a
push-and-pull dynamic in Nicaragua: individuals become
self-employed and start-up microenterprises during bad eco-
nomic times, and then leave them for salaried jobs when the
economy is strong (Pisani & Pagan, 2004). In severe economic
crises, MSEs may be more resilient than their larger counter-
parts. During the East Asian economic crisis, many small-scale
rms fared better than larger companies in Indonesia (Berry et
al., 2002), and microenterprises were the most likely to repay
their loans to Bank Rakyat Indonesia (Patten, Rosengard, &
Johnston, 2001).
Macroeconomic and relative price volatility is also an
important issue for MSE growth, as experience has shown
in Latin America and Sub-Saharan Africa (Tybout, 2000).
A recent survey of 500 MSEs in Ghana found that entrepre-
neurs perceived their three greatest problems to be ination,
high interest rates, and the depreciation of the local currency
(Robson & Obeng, 2008). IFC surveys of 10,000 rms in 80
countries found that both the ination and the exchange rate
tend to aect MSEs more than larger rms (Schier & We-
der, 2001). 8 In many developing countries, credit market fail-
ures also put constraints on small rm growth. MSE owners
often claim that insucient credit is their most pressing
obstacle, though entrepreneurs perceptions may not neces-
sarily correspond to actual barriers to growth. The IFC study
found that more than any other obstacle, nancing was
ranked as one of rms top three challenges (Schier &
Weder, 2001).
The regulatory and institutional environment in developing
countriesnotoriously burdensome when compared with that
of developed countries (World Bank, 2006)frequently ham-
pers small enterprise growth. An econometric analysis of rm-
level data in 54 countries suggests that nancial, legal, and cor-
ruption challenges disproportionately constrain the growth of
smaller rms (Beck, Demirguc-Kunt, & Maksimovic, 2005).
For instance, strict regulations and high taxes may keep rms
small and informal (De Soto, 1989). Regulatory and institu-
tional challenges may deter MSE owners from making
growth-enabling investments, while special subsidies and trade
protection oer greater benets to larger rms, which are often
more capable of lobbying (Tybout, 2000). Smaller rms more
frequently report government policies to be unpredictable, and
this uncertainty may be yet another factor that reduces
growth-enabling investments (World Bank, 2005).
1459
Ironically, government policies that aim to benet MSEs
may suppress growth if they provide disincentives for employ-
ment expansion. For example, India oers attractive incentives
to small enterprises, but by some accounts, these measures
backre because growth beyond a specied level entails losing
valued benets (Little, Mazumdar, & Page, 1987; Mitra & Pin-
gali, 1999). The manufacture of certain products in India is re-
served for small rms, which reduces incentives for rm
expansion (World Bank, 2005). Some owners even split up
their MSEs into several enterprises in an eort to make them
look smaller (Kashyap, 1988).
While there appears to be consensus on what constitutes a
negative business environment, much less has been written
about what a positive one looks like. There are a few generally
agreed upon characteristics, however: a stable macroeconomic
environment; the existence of mechanisms for contract
enforcement and dispute resolution; consistency, so that busi-
ness owners know what to expect and can assess risks; an
uninhibited ow of capital for foreign and domestic invest-
ment; a exible labor regime; access to information; and
investment in education and technology.
10. IMPLICATIONS FOR DEVELOPMENT
PRACTIONERS
The vast majority of micro and small enterprises in develop-
ing countries never expand beyond a few employees. But a few
high performance MSEs experience rapid and substantial
growth; their expansion drives most of the aggregate growth
in the MSE sector. This study has explored numerous factors
associated with small rm growth. Based on the evidence pre-
sented, Table 1 provides an overview of the relationship be-
tween each factor and MSE growth in both the developing
and developed-country literature (Columns 1 and 2). Existing
studies provide considerable insight about these factors, but
less is known about the factors relative importance or how
they interact with each other.
Investigating the mechanisms by which these factors aect
MSEs can help to clarify whether they actually cause rm
growth or are just associated with other growth determinants.
There are various plausible mechanisms, but we highlight two
channels that we believe deserve particular emphasis in future
researchopportunities and capabilities. More specically, ac-
tors can enhance MSE growth by: (1) expanding protable
business opportunities or (2) enhancing rm capabilities to
harness opportunities.
Opportunities for protable business activities clearly aect
the ability of an entrepreneur to expand his or her rm.
However, protable business opportunities are necessary
but insucient condition for rm growth. 9 To take advan-
tage of these opportunities, entrepreneurs must also possess
appropriate capabilities, such as skills, resources, and tech-
nology. This article has provided preliminary insights into
the potential eects of growth factors on opportunities and
capabilities. Based on these insights, Table 1 (Columns 3
and 4) provides initial hypotheses about how each factor
may aect rm growth through opportunities, capabilities,
or both.
Further research should pay close attention to how factors
shape rms opportunities and capabilities, as well as to other
mechanisms by which factors potentially aect MSE growth.
Factors inuencing both opportunities and capabilities may
oer more powerful levers for development programs. If fur-
ther research supports this hypothesis, development practitio-
ners designing programs to stimulate MSE growth may
1460 WORLD DEVELOPMENT

Table 1. Growth factors and MSE growth, opportunities, and capabilities

Growth factor 1. Link to MSE growth 2. Link to MSE growth 3. Impact on opportunities 4. Impact on capabilities
(developing countries) (developed countries) (hypothesized) (hypothesized)
Education of owner (above threshold) + + + +
Work experience of owner + + + +
Gender (female-owned) 0
Firm located in household
Firm age (older) 0
Informality 0
Access to nance + + 0 +
Social networks (strong and diverse) + + + +
Value chains (favorablea) + + + 0
Inter-rm cooperation (favorable) + + + +
Business environment (favorable) + + 0
Note: Cell marked with 0 if the literature suggests no association with MSE growth or no hypothesized direct impact on opportunities/capabilities.
Blank cells indicate factors with considerably less evidence in the developed country literature.
a
Assumes the presence of one or more of the following: (a) strong and sophisticated demand; (b) sectoral characteristics that allow for MSE competi-
tiveness; and (c) power structures that allow for MSEs to ourish.

consider focusing on dual-mechanism factors such as educa-
tion, work experience, or inter-rm cooperation.
Many MSEs in developing countries lack both protable
business opportunities and capabilities such as skills, re-
sources, and technology. These rms demonstrate the least
proclivity toward growth, and their owners may focus instead
on rm survival. Despite their lack of growth, these MSEs fre-
quently play important social and economic roles. Even if they
do not experience employment growth, they often provide
essential sustenance for their owners and workers. In some
cases, slow or nonexistent rm growth may also be attribut-
able to entrepreneurs competing interests. Women MSE own-
ers, for example, may be especially likely to use business
proceeds to purchase household necessities, to invest in paral-
lel enterprises, or to assist their ospring in launching new
rms.
Should micro and small enterprise development programs
try to pick winners, focusing only on those rms most likely
to grow? For example, should programs avoid informal, fe-
male-owned rms located in the household? We emphatically
answer no. Many development practitioners and developing-
country policymakers nd the picking winners formula to
go against the very principles and goals around which their
programs are conceived, not to mention being politically di-
cult to implement.
Rather than simply picking winners, micro and small
enterprise development programs should be clear about their
objectives. Practitioners should avoid unrealistic objectives
such as broad-based MSE expansion, because a wide range
of evidence from both the developing and the developed world
shows that only a small subset of MSEs are likely to grow sub-
stantially. Practitioners should thus be clear, for example,
about whether they aim to unleash the untapped growth po-
tential of latent gazelles, or whether they aim to stabilize the
incomes of the poor by providing assistance to survivalist
MSEs. Such questions are crucial for designing MSE develop-
ment programs. Although all MSEs are likely to benet from
certain types of interventionssuch as alleviating market fail-
ures in creditlatent gazelles are likely to require types of spe-
cialized development assistance that are substantially dierent
from what survivalist MSEs need. Being explicit about objec-
tives is a basic but all-too-often-overlooked step in the eort to
develop eective, customized programs. Of course, programs
with multiple objectives will often face dicult tradeos.
How to balance these objectives should be considered explic-
itly from the outset.
The present study can be employed as important input in
designing customized MSE development programs to achieve
specied objectives. Developing eective programs for the en-
tire MSE sector is often especially challenging because the
sector represents the vast majority of rms in nearly all coun-
tries. The MSE sector is both large and heterogeneous, so seg-
mentation can play an important role in developing tailored
programs. A segment is a group of rms that shares relatively
similar key characteristics (such as growth trajectory, opportu-
nities, and capabilities), but that is substantially dierent from
other segments. Using several of the variables examined in our
study, Figure 1 provides an example of potential MSE segmen-
tation in a given country. Numerous segments would likely be
identied, but for illustrative purposes we highlight and dis-
cuss below two potential segments, latent gazelles and sur-
vivalist MSEs.
When based on rigorous analysis of quantitative and/or
qualitative data in a particular country or region, segmentation
can enable practitioners to tailor interventions to the specic
needs of MSE segments. Although a thorough discussion of
segmentation methodologies is beyond the scope of the present
article, the primary tasks for development practitioners would
include: 10
(1) Identify potential segmentation variables: Our study pro-
vides an important contribution by identifying variables
linked to MSE growth, opportunities, and capabilities.
Through brainstorming, practitioners can identify other
measurable variables that may also be used to segment
the MSE sector in their particular country or region.
(2) Create an MSE segmentation frame: To determine
which identied variables should be included in the frame
(i.e., placed on the vertical and horizontal edges of Figure
1), practitioners would analyze which variables best predict
characteristics such as MSE growth, opportunities, and
capabilities in their country or region. Depending on the
local resources and data availability, practitioners may rely
more heavily on quantitative analysis (e.g., factor analysis
or cross-tabulations of survey data) or qualitative analysis
(e.g., interviews or focus groups across dierent variables).
(3) Dene homogeneous segments: To dene segments,
practitioners can use quantitative and/or qualitative analy-
sis to examine characteristics such as growth, opportunities,
and the capabilities of rms within each individual cell in
the segmentation frame. Collapsing cells that are relatively
similar across these or other key characteristics enable
practitioners to dene a tractable number of homogenous
 SMALL FIRM GROWTH IN DEVELOPING COUNTRIES 1461

Figure 1. Segmentation of MSEs in a hypothesized country.

segments. For example, four cells are collapsed as shown in
Figure 1 to dene the hypothesized survivalist MSEs
segment.
(4) Create segment proles: To deepen their understanding
of the particular attributes of each newly dened segment,
practitioners can use existing quantitative and qualitative
data. Where resources are available, focus groupseach
made up entirely of MSEs from a given segmentmay be
helpful.
(5) Prioritize target segments: Practitioners can prioritize
these newly dened segments based on the explicit program
objectives. For example, MSE programs specically aiming
to stabilize income of the poor may choose to focus eorts
on segments such as Survivalist MSEs.
(6) Develop customized interventions: Segment proles
enable practitioners to develop customized interventions
tailored to the specic needs of respective segments. Once
these programs are developed, practitioners can easily iden-
tify which segment a rm belongs to and what customized
interventions (or services) it should receive or have access
to, based on the objective variables in the frame (e.g., own-
ers education and formality in Figure 1).
The recognition that not all small rms will grow, combined
with a rigorous segmentation that proles what dierent types
of MSEs are most likely to need, oers a powerful alternative
to traditional small enterprise development programs. Tradi-
tionally, donors have conducted needs assessments to iden-
tify the constraints aecting small rms in a particular region,
country, or sector. This type of research, however, frequently
makes implicit assumptions that are not accurate for all
MSEs. For example, many traditional programs assume that
entrepreneurs aim to grow their rms, and as a result, inter-
ventions may be designed with the sole purpose of stimulating
such growth. These programs may be deemed failures and dis-
continued if they do not result in broad-based MSE growth.
New approaches to design, intervention, and evaluation cycles
based on the insights of this and future studies oer the poten-
tial for improved development outcomes.

NOTES

1. To identify the most inuential studies on small rm growth, we used
the Web of Science to determine the 100 most frequently cited articles in
each 5-year period over the past 50 years. To consider recent research (that
may not yet be cited), we reviewed every article published on small rm
growth in the past 5 years and employed Google Scholar to nd relevant
working papers. To ensure that we reviewed important books on the topic,
we solicited recommendations from the experts listed below.
reect the views of all experts and we are solely responsible for its
content.
3. Interview with Donald Mead, 2004.
4. In other words, all economic activities that would generally be taxable
were they to be reported to the state (tax) authorities (Schneider, 2002).

2. Experts interviewed include Thorsten Beck (World Bank), Albert
Berry (University of Toronto), Ronald Cooper (US Small Business
Association), Gustavo Crespi (University of Sussex), Antonie de Wilde
(World Bank), Brian Headde (US Small Business Association), Hugo
Kantis (Universidad Nacional de General Sarmiento), Juan Jose
Llisterri (Inter-American Development Bank), Donald Mead (Michigan
State University), Reshmi Mitra (XLRI Jamshedpur, India), and Carlos
Moreno (SODIMAC Colombia). Although the present article incorpo-
rates ndings from each interview, the article does not necessarily
5. Social networks refer to micro-level relationships between agents in an
economy. Social networks can be considered individual assets, but are
distinct from physical and human capital because they include interper-
sonal relations (Portes & Landolt, 1996).
6. In addition to the sub-sector focus of the value chain literature, many
empirical studies (particularly in developed countries) explore how sector
and location inuence rm growth (e.g., Audretsch, 1995; Audretsch &
Dohse, 2007; Tong, Todd, Reuer, & Chintakananda, 2008).
1462 WORLD DEVELOPMENT
7. Presentation at the Brazilian National Development Bank (BNDES)
in April 2001.
8. The ndings of both Robson and Obeng (2008) and Schier and
Weder (2001) provide an indication of rm owners perceptions of factors
aecting their MSEs, and not necessarily the actual impact of these
factors.
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