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February 7th, 2017

Doing business in Somaliland: Looking beyond the regulatory environment

1 comment | 3 shares

Estimated reading time: 10 minutes

Blog Editor

February 7th, 2017

Doing business in Somaliland: Looking beyond the regulatory environment

1 comment | 3 shares

Estimated reading time: 10 minutes

Nimo-ilhan Ali and Nasra Jama detail some of the challenges facing small-scale entrepreneurs in Somaliland.

Amaah, a Somali word that roughly means ‘loan’, is perhaps one of the most important words used in Somaliland to describe the relationship between customers and small business owners. To ensure customers loyalty, small businesses selling basic food and non-food essentials have to offer a line of credit, amaah, to the majority of their customers for an extended period of time. Failure to offer amaah results in losing customers who would simply take their business to the next shop willing to extend them a line of credit.

Both of the above options have a detrimental impact to business owners: Offer amaah and face the threat of going bankrupt when customers fail to clear their accounts either on time or at all, refuse, and you would lose customers and potentially face bankruptcy anyway. Standing surrounded by a wide range of fresh vegetables and other basic food and non-food items, a shop owner in Hargeisa, the capital of Somaliland, whom we call Abdi, deliberates this issue. He shakes his head and says:

 “It will be better and healthier for my business if I lowered the price of all my goods instead of giving them out as amaah. But, I have no choice. None! You have to give amaah if you want to keep customers.”

The dilemma faced by Abdi and many other many small business owners in Somaliland is rarely covered in policy documents and studies about the ease of doing business in these settings. In fact, when we talk about the ease of doing business in different African countries, we pay a disproportionate amount of attention to the regulatory environment that firms face in establishing and maintaining their businesses. The focus in these discussions is the relationship between the state and medium-to-large scale firms with the assumption that once the state provides an enabling regulatory environment, then firms should thrive.

A host of indicators to gauge the regulatory environment – covering the initial registration process, the ease of accessing credit, the protection of investors, the paying of taxes, the judicial processes to monitor contracts, and the laws surrounding insolvency – have been developed and are used to rank and compare the ease of doing business in Africa with other economies around the globe.

While the regulatory environment is indeed crucial especially for medium-to-large scale entrepreneurs operating in relatively formal environments, what gets much less attention is the environment in which a large number of very small-scale entrepreneurs, the largest category on the continent, operate.

Like Abdi, these entrepreneurs are very small and largely operate in informal settings where the majority of indicators developed to measure the ease of doing business, simply do not apply. Though important, it is not their relationship with the state that determines the success or failure of their businesses, rather, it is their relationship with their core customers, the countless number of poor households struggling to make ends meet, that matters the most.

The ubiquitous very small entrepreneur

Although livestock continues to be the bedrock of the Somaliland economy in regards to its contribution to the country’s GDP, the number of people benefitting directly from this sector has significantly declined. In the 2012 Labour Force Survey , The International Labour Organization (ILO) found that in contrast to prevailing expectation, the biggest employer in the country was not the livestock sector, but the sales and services sector. This sector is also the biggest employer of women.

While the sales and services sector in Somaliland contains a handful of medium sized firms such as the money transfer companies, telecommunication, construction and wholesale suppliers, the bulk of businesses in this category are extremely small employing no more than one or two family members. These businesses are mostly small shops selling basic food and non-food items.

An example of a small shop selling basic food and non-food essentials in New Hargeisa Photo Credit: Nasra Jama
An example of a small shop selling basic food and non-food essentials in New Hargeisa
Photo Credit: Nasra Jama

An analysis of the initial investments used to start these businesses highlights just how small the endeavours are. In our research where we interviewed 141 business owners in Hargeisa, we found that 85 per cent of the businesses were established for US$5,000 or less. Many within this group had been initiated for less than US$2,000. In fact, over a third of the all businesses we interviewed were established for US$1,000 or less.

Given the small size of initial investments, business owners reported that access to formal credit facilities, a key indicator of the ease of doing business, was not one of their key concerns when starting their business. Although this might be due to the lack of formal credit institutions in the country, it might also reflect the fact that establishing a business for the largest part of the Somali population has always been a family affair and formal credit, even before the war, was not accessible to many potential small business owners.

Entrepreneurs reported that although they utilised multiple sources to secure initial funding, family and relatives was their main source. Often funds came from multiple family members and relatives residing across different countries. Although most of this support was a gift and therefore did not need to be paid back, a small proportion were loans from relatives that needed to be paid back at a later date. Given the small size of investments, some entrepreneurs noted that they used their own savings to start their business. Former wages and salaries were noted to have been a key source of these savings. A small minority noted that they had sold their assets, mainly land and livestock, to finance their business endeavours.

Staying in business

While establishing even a very small business is not without its challenges – such as lack of local market know-how as well as difficulties finding a suitable location for the business – business owners in Hargeisa reported that establishing their businesses was much easier compared to the challenges they faced in trying to maintain them. Overwhelmingly, almost all of the business owners reported that maintaining their businesses was heavily compromised by the prevailing amaah practice.

To keep customers returning to their shops, shop owners have to advance a credit facility for a customer to take items without having to pay upfront for an extended period of time, often a month but sometimes more. Although some customers clear full or part of these loans after a month and begin a new cycle, others fail to clear their debt leaving owners struggling to restock their shelves and keep their business afloat.

This practice is heavily utilised by a large number of households in Hargeisa especially for accessing basic food and non-food essentials. This system is in fact an important household strategy to manage their scarce resources. For many households in Hargeisa, monthly incomes are almost entirely derived from their remittance incomes, which mainly arrive once a month from a single sender. Remittance incomes tend to be fixed with little variance in the amounts received each month.

An analysis of the monthly expenditure patterns of urban households suggests that they spend a large proportion of their monthly remittance incomes on food, followed by basic non-food items. Key non-food expenditures include education, gifts to relatives, healthcare and electricity. While remittance incomes are more or less fixed, the amount households spend on food varies depending on the prevailing food prices: food prices tend to go up during drought and currency fluctuations. In addition, healthcare costs can increase in a particular month leaving households short of funds.

Since it is a lot more difficult for households to access credit to pay for key non-food expenditure such as education (children are sent home when they fail to pay their school fees), when funds are short households are forced to reduce the cash amount allocated to basic food and non-food items. However, since households cannot, in reality, survive without these key essentials, approaching their neighborhood shop owners for a line of credit is their only option.

Shop owners have little option but to extend this credit. Given the abundant number of shops selling similar items located next to each other, customers would simply try next door. To keep customers, shop owners have to agree to this arrangement. Each day, shopkeepers diligently record items customers take with the hope that at the end of the month, when customers receive their remittances, some accounts will be cleared.

Shop owner in New Hargeisa now offering tailoring services Photo Credit: Nasra Jama
This shop owner in New Hargeisa now offers tailoring services
Photo Credit: Nasra Jama

While this system works as an efficient overdraft facility and provides a crucial livelihood lifeline for these households, it presents business owners with enormous challenges. Even though a large number of households do clear their accounts in part or full at the end of each month, some do not clear on time (for instance when their remittance is late) or fail to clear completely for one reason or another. Taking into account how small these businesses are, the loss of this income can have huge ramifications to the owners’ ability to restock shelves and the outcome for most is bankruptcy.

Surviving Amaah

Some business owners are, however, coming up with strategies to survive the inevitable amaah practice. Some have formed similar arrangements with their supplier and can continue restocking their shelves without having to pay for the stock upfront for an agreed period of time. Others have diversified their businesses and have started to offer other services in their shops such as tailoring, which are largely excluded from the amaah practice.

Nonetheless, for many very small businesses operating in Hargeisa, businesses that are crucial for employment and livelihood opportunities for a large number of people, keeping their businesses afloat while maintaining their customer base, remain an immeasurable challenge. If they refuse to extend credit, they lose customers and if they agree, they could potentially lose their businesses.

For these entrepreneurs, it is not dealing with construction permits, getting electricity, registering property, getting credit, protecting investors, paying taxes, trading across borders, enforcing contracts and resolving insolvency – as captured by Doing Business in Hargeisa 2012  – that constrains them. It is the type of business relationship that they are embedded in with their customers – a relationship that is akin to being trapped between a rock and a hard place – that crucially restrains their ability to thrive.

A version of this article was first published in the Finnish journal, African Sarvi.


Nimo-ilhan Ali (@IlhanNimo) is a post-doctoral research associate at SOAS, Development Studies Department. She’s the author of ‘Going on tahriib: The causes and consequences of Somali youth migration to Europe’ (Rift Valley Institute 2016). She can be contacted at nimoali04@gmail.com.

Nasra Jama is a senior researcher at Altai Consulting based in Hargeisa, Somaliland. She can be contacted at nasra-sagal@hotmail.com

 

The views expressed in this post are those of the author and in no way reflect those of the Africa at LSE blog or the London School of Economics and Political Science.

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