Empirical Evidence on the Importance of Managerial Capital Miriam Bruhn (based on work with Dean Karlan and Antoinette Schoar) DIME-FPD Global Conference and Workshop on Development Impact Evaluation in Finance and Private Sector June 6, 2011

Motivation: What Constrains Firm Growth? Small and medium size enterprises (SMEs) in developing countries seem to grow slower than equivalent firms in the developed world  Less transition from small to large firms  Documented high returns of small firms suggest they are sub- optimally small (i.e. constrained from growing) Need to understand bottlenecks that prevent SMEs from growing  Focus has been on access to finance  In the past, comparatively little attention has been paid to the role of managerial (human) capital and management skills  But there are several new and ongoing studies in this area

Why Is Managerial Capital Important? Managerial capital can affect the productivity of firms  Improving managerial capital can lead to higher production with the same amount of inputs (for example, by maintaining machinery or identifying better marketing or pricing strategies) Better managerial capital can also improve decisions on the amount and type of inputs a firm buys or rents  Increasing managerial capital can improve the way in which firms use their financing, increasing the impact of access to finance

Cross-Country Evidence on Management Skills Management education, as well as management practices tend to be of lower quality in developing countries than in developed countries  In a survey, firms in lower income countries were more likely than firms in higher income countries to say that locally educated MBAs were inadequately prepared (Chaudry, 2003)  Firms from non-Organization for Economic Cooperation and Development (OECD) countries score significantly below firms from OECD countries on a measure of management practices (Bloom and Van Reenen, 2010)

Impact Evaluation Questions Does lack of managerial capital impede the growth of small and medium size businesses in emerging markets? Can a lack of managerial knowledge be alleviated by providing training or consulting services? Several recent and rigorous impact evaluations aim to answer these questions by Offering business training or consulting services to a randomly selected group of firms (e.g. among firms interested in participating) Later comparing business practices and performance to the firms that were randomly selected to not be offered training/consulting

Overview of Existing and Ongoing Impact Evaluations Many completed and ongoing impact evaluations focus on micro firms/self-employed, often providing class- room based business training in collaboration with a microfinance institution Peru: Karlan and Validivia (2010), Pakistan: Gine and Mansuri (2011), and others Relatively fewer studies focus on small, medium, or large firms Also, relatively few studies provide individualized consulting rather than class-room type training

Impact Evaluation in Puebla, Mexico Conducted a randomized impact evaluation of a program that provided management consulting services to micro, small and medium size businesses  The program was implemented with IPPC, a training institute of the state of Puebla  The provision of services was highly subsidized, so firms paid only between 10%-25% of the actual costs, depending on firm size Firms were paired with one of 9 local consulting firms  Consultants met with businesses for at least 4 hours a week for a one year period from January to December 2008  Consultants were asked to (1) diagnose the problems that prevented the firms from growing, (2) suggest solutions that would help to solve the problems and (3) assist firms in implementing the solutions

Defining the Study Sample IPPC advertised the program widely within Puebla to attract eligible firms Only firms formally registered with the tax authority were eligible to participate in the program  The program was designed to include funding for 100 micro firms (<=10 employees), 40 small firms (11-50 employees) 10 medium-sized firms ( employees) Interested firms had to apply to IPPC and sign a letter of interest to participate in the program and to be considered for the subsidy This letter also explained that selection into the program was random, so that not all interested firm would receive a spot

Research Design and Take-Up (Challenges) 433 firms signed the letter of interest, saying they would participate in the program if offered a spot Randomly selected 149 firms to be offered a spot in the program (treatment group), the remaining 284 firms serve as the control group Out of these 149 firms, only 79 firms (53%) ended up participating in the program The others said they had changed their mind or did not have sufficient funds to pay their share of the consulting anymore For the research design, it is crucial that the remaining spots in the program cannot be filled with control group firms IPPC recruited firms outside the study to fill the spots

Data Collection Baseline Survey  Conducted in Oct-Dec 2007 after firms signed letter of interest but before they were assigned to treatment and control groups First follow-up Survey  Conducted in March-May 2009  Re-interviewed 88% of the firms interviewed at baseline  17 firms had closed and the rest declined to participate in the interview In-depth case-studies of 8 firms Conducted in June 2009

Sample Characteristics Industry distribution of firms – Manufacturing sector: 30% – Commerce and trade: 25% – Services sector: 45% Firm characteristics at baseline: Median firm has about 6 full-time employees (average = 14) Median monthly sales of USD 9,500 (average = 63,000) Median monthly profits of USD 2,200 (average = 12,000)

Examples of Firms in the Study El Mundo de las Mascotas Pet and toy store Run by father and son 8 employees (in 3 branches)

Fumigaciones Sigo Pest control services Sole proprietorship 4 employees Front entranceThe entrepreneur in his office

Main office Water distribution truck Transporte y Renta de Pipas Palacios Water transportation Sole proprietorship 6 employees

Balance of Characteristics Across Treatment and Control Groups Since the treatment and control groups were randomly selected, their background characteristics are the same on average, making the control group a valid comparison group…

Balance of Business Performance Variables Across Treatment and Control Groups …BUT the business performance variables look less similar on average These variables have very large variance and the averages are influenced by outliers  Trimming outliers makes the averages more similar

Topics that Firms Worked on with Their Consultants (from 8 Case Studies) Topic# of firms that covered this topic Define mission and vision statements6 Accounting and record keeping (training and/or new software)5 Clarify organizational structure, clearly assign responsibilities5 Sales strategy and advertising (marketing)4 Strategically select location and number of sales points2 Quality control2 Access to credit or alternative financing solutions2 Human resources management and hiring practices2 Mediate family problems in family firms1 Pricing strategy1 Reduce costs (negotiate with suppliers, find alternative suppliers)1 Figure out with products are most profitable and focus on these1 Team work and communications training for employees1 Leadership training for firm owners1

Impact on Business Practices Compared to control firms, treatment firms at follow-up (after 1 year of consulting) Were 7% more likely to keep formal accounts (93 vs. 86% of firms) Were 13% more likely to have launched a new marketing campaign during the past year (57 vs. 44% of firms) Had principal decision makers with higher measured entrepreneurial spirit

Impact on Business Performance Results suggest that the consulting improved business performance for firms in the treatment group  Productivity was significantly higher in treatment than in control group after one year of the program  Sales and profits improved by more than 70% each (but results are sensitive to trimming outliers)  Results are only statically significant at the 10% level, likely because of the noise in the data  Also, not all firms answered the questions about sales and profits, reducing the sample size

Impact on Business Outcomes

Impact on Employment Find no statistically significant increase in employment  Maybe employment takes more time to change  We are only measuring effects after one year of the program  We tried to conduct a second follow-up survey after two years (one year after the first follow-up), but the response rate was low

Cost-Benefit? The hourly cost of consulting varied with firm size, but was USD 60 on average  USD 60 x 4 hours x 52 weeks = USD 12,480 per firm for one year of consulting  This is the total cost, of which firms only paid 10-25% The program increased monthly profits by about 70% = USD 6,000 compared to profits in control group (USD 8,600)  Annualized, this corresponds to USD 72,000  Caution: Do not know for how much time the monthly profit increase will persist

Conclusions Suggestive results that providing management consulting can improves sales and profits for small firms This confirms the hypothesis that managerial capital can be a limiting factor in the growth of firms in developing countries  It also shows that this managerial capital can be transmitted via consulting services Open question: the benefits appear to be greater than the cost – why don’t more firms use consulting services? Possible reasons Lack of information about the benefits Lack of available funds to pay for the services (financing constraints)

Impact Evaluation Lessons Learned A larger sample size is needed to detect more statistically significant effects on sales and profits, because  These outcomes are very noise  Take-up rates of the program may be low, diluting the effect (a large sample allows for detecting smaller effects) Need to find a way of increasing response rates to sales and profits questions Would be good to collect more rounds of data, but in this case many firms did not want o participate in the additional survey