Turning BDS Into Business Chapter 4: Challenges and recommendations for Indonesia

Free or subsidized BDS provision by government and donors has in most cases negatively affected BDS supply, while hardly influencing BDS demand. Availability of BDS to SME can only be improved sustain ably, if providers work commercially and financially self-sustainable. Otherwise demand-orientation and efficient service provision cannot be ensured. Government and donors should accept that BDS provision is essentially a private sector task and activity. External interventions should aim at promoting efficient BDS markets. This may include activities geared at preventing or reducing market distortions, enhancing market transparency and transaction security, and improving the quality and regional coverage of commercial BDS supply. Primarily, regulative instruments should be used for these purposes. Direct interventions should be non-discriminatory in character, have to be legitimized by significant market and institutional failures, and must be targeted towards overcoming such failures.

The challenge – stimulating demand and supply simultaneously

Successful development of the BDS market has to address BDS demand as well as supply. A focus on BDS supply only will hardly be effective, since many supply-side constraints originate from SMEs' current low usage of paid BDS. Based on data from the TA's SME survey, the total annual volume of commercial BDS provision to SME in Indonesia has been estimated at some 200 billion IDR (20 million USD). Even if including additional revenues from vouchers and matching grants, and service sales to micro-enterprises and individuals, which are not included in the above estimate, the market volume is too small to support a diversified service supply across the whole country, and leaves providers with few opportunities and resources for product development and marketing.

Demand-oriented strategies are in general more promising. However, they risk that activated demand cannot be satisfied due to qualitatively or regionally insufficient service supply. A point in case is SMEs' current low usage of productivity & performance enhancing services in relation to latent demand, which partially reflects negative impacts of government and donor sponsorships, but also relates to fundamental skills and managerial deficits.

Enhancing driving forces for BDS demand

In general, any policy action geared at removing market barriers and enhancing competition strengthens the demand for BDS. Specific attention has to be given to the following areas:

• Improving SMEs' access to (investment) finance. Respective actions should include creation of a credit information system, review of prudential lending regulations, re-focusing government credit programs onto long-term credit at market conditions, as well as strengthening providers of alternative finance such as MFIs, sharia banks, as well as leasing, factoring and venture capital.

• Removing barriers to international trade including imports: Aside from continuing with general trade liberalization in line with ASEAN and WTO agreements, attention should also be given to simplifying or abolishing import licenses and tax withholding on imports, as well as reviewing the various export taxes and Sales Tax on Luxury Goods due on various imports. Liberalization of service sectors, in particular telecommunication, requires particular attention and efforts.

• Promoting business registration and formalization, among others by streamlining business licenses, introducing one-stop services, and improving information on registration requirements and procedures.

• Improving tax coverage and compliance by reviewing and simplifying tax laws, improving access to tax-related information, and containing corrupt taxation practice. Particular attention should be given to the possibility of extending partial non-collection of VAT according to Article 16B of the VAT law to SME that are currently VAT-exempt according to Article 1 of the VAT law. Such partial non-collection of VAT could be a powerful incentive for small enterprises to improve their tax compliance, while at the same time delivering cross-checking possibilities for the tax administration with respect to the tax compliance of suppliers and clients of these small enterprises. Based on results of the TA's survey, it has been estimated that improved tax coverage and compliance could raise SMEs' usage by some 40%, including trigger effects on demand for accounting and IT services and management and financial consultancy.

• Implement a new approach towards enforcement of norms and standards based on certification by accredited providers. There are examples of external certification, such as audit requirements for companies listed on the stock exchange, or ISO 9xxx certification. However, compliance with standards and norms is still mainly supervised by the government. In areas of prime public concern such as fire security, mandatory regular certification by accredited independent auditors should be gradually introduced. Voluntary certification is in many cases still done by the regulatory authority instead of being entrusted to qualified accredited providers. Opening up, e.g., 'halal' certification to external auditors that undergo accreditation with and are supervised by the Council of Ulemas could greatly enhance service demand and reduce certification cost for companies outside Jakarta. Cooperation with international accreditation organizations should be enhanced to promote mutual recognition of audits and certificates. Attention has also to be given to creating an adequate legal framework, including regulation on provider liability.

Minimizing Intervention And Market Distortion By Government And Donors

In order to promote effective BDS markets, provision of BDS by the government and donors should be minimized and restricted to

• Services related to public functions, e.g. protection of intellectual property rights;

• Services/programs explicitly running under wider objectives such as poverty alleviation, consumer or environmental protection; and

• Services geared at fostering public-private partnership and/or supporting respective reorientation of public institutions.

Even in the aforementioned cases, serious consideration must be given to possibilities for commercial service provision before embarking on direct service provision by the government.

For continuous review of ongoing programs and regular mandatory pre-screening of new proposals, an inter-ministerial working group under the proposed Small Business Council (SBC) should be established. The review should also include programs of state-owned enterprises that have no direct relation to their business activity. A similar review is required for public institutions involved in BDS provision. Line ministries should in co-ordination with each other elaborate a detailed agenda for restructuring service providers under the national government.

The donor community can actively contribute by phasing out institutional sponsorships for BDS provision and assisting in restructuring of public institutions.

Focus on supporting feasible business models

To improve BDS supply outside major urban centers on Java, supply-oriented actions should focus on such service combinations / business models which can support relevant provider numbers:

• Accounting for almost half of SMEs BDS expenditure, tax advisors, accountants and lawyers will have to be the prime field structure that provides BDS outside large urban centers. No other BDS segment can support similar provider numbers in Indonesia.

• As secondary, albeit less dense field structure, providers of sales-related services including advertisement, information services and marketing assistance should be promoted.

• In clustered regions, there is potential for providers offering a full service range for a specific sector that includes combined technical/ management training, management, production and operation assistance, and sector-specific marketing & investment consultancy. Such sector/cluster-specific providers will in rural regions often be agro-focused. While respective privately-owned providers should in no way be discriminated, it appears to be particularly promising to promote development of respective commercial services by local business associations. Such business associations could integrate service provision to SMEs with other activities such as vocational training.

Large urban agglomerations may provide opportunities for more sophisticated and more specialized service providers, including providers of IT services. However, respective provider numbers will in most cases be too small to justify specific activities.

Strengthening BDS supply

BDS supply should primarily be strengthened by:

• Improving academic education in BDS-relevant areas such as taxation, accounting and controlling, business diagnostics, market analysis, business strategy and planning, as well as supply-chain and quality management. Particular attention in this respect should be given to promoting case-study based training instead of theoretical education based on text books. Academic institutions should also be encouraged to develop and offer short skills upgrading offers geared at BDS practioners.

• Promoting provider networks by strengthening professional organizations, organizing provider forums and promoting the use of electronic media in information exchange. Issues to be discussed in provider forums may include exchange on feasible business models and specific service ideas, as well as management and controlling issues..

• Removing entry and transaction barriers and regulative constraints - this concerns in particular restrictions for foreign investors, as well as tax withholding on BDS provision to incorporated clients.

In addition, market transparency may be enhanced by associations and public institutions maintaining and publishing lists of service providers deemed to be qualified in a specific field, such as NAFED's list of resources for export training.

Specific interventions

Stand-alone technical assistance and provider training is not recommended. Outreach, efficiency and chances for sustainability are higher if such activities are connected to promoting provider networking and improving academic education, respectively. Specific skills deficits may be addressed through matching grants with an integrated strong provider capacity building component. The following matching grant schemes are specifically recommended:

• Matching grant scheme for assistance in business diagnostics and business strategy development in order to address significant skills deficits among providers and promote respective services which are yet widely unavailable;

• Matching grant scheme for product and process improvement and co-operative research. In order to increase outreach, the new scheme shall not only support external assistance to individual enterprises, but also support joint research of SME groups carried out in cooperation with research institutes, technology-oriented service providers, or equipment and component suppliers;

• Matching grant scheme for first-time input and output market research of business associations in order to improve the overall quality of information services offered, as well as strengthening business associations in general.

In addition introduction of regional Voucher Programs is recommended. Such programs are ideally established by several districts in co-operation. Even though local funding should in general be no problem, it is recommended for the national government to establish a support facility for local voucher programs as incentive for inter-district co-operation.

Design and implementation of the aforementioned programs will require specific knowledge and skills. Therefore, co-operation with donors and outsourcing of program management is strongly recommended.