The BEE codes are inhibiting SA’s SME development

JOHANNESBURG - The American sociologist, Robert K Merton, popularised the term “unintended consequences” in 1936 with his paper “the unanticipated consequences of Purposive Social Action”.

He sought to demonstrate that government actions aimed at bringing social change will always bring unintended consequences. There are three categories of unintended consequences: unexpected benefit (luck); unexpected drawback (bad luck); and perverse result (bad luck that worsens the targeted problem).

Since 2003, Black Economic Empowerment (BEE), as South Africa’s main policy tool for the transformation of South Africa’s socio-economic order, has proven him right. In its first iteration, BEE focused on equity transactions. It saw corporate SA rushing to give shares and board seats to a small number of politically connected black individuals. This had the drawback of leaving most South Africans excluded from the economic benefits of the 1994 political transformation.

In the face of widespread protests, Smuts Ngonyama (head of the ANC Presidency) infamously responded to questioning of those BEE practices by stating – with insensitivity that would have made Marie Antoinette blush – that he “did not join the struggle to be poor”.

Things had to change, and they did: 2007 saw the enactment of Broad-Based Black Economic Empowerment (B-BBEE) through the Codes of Good Practice.

Enterprise Development (ED) was introduced to drive entrepreneurship and SME development. These became accepted as key drivers of economic growth and job creation. ED required corporates to invest 3% of Net Profit After Tax (NPAT) in developing SMEs. Unfortunately, most corporations simply donated the required money without much bothering about the development impact realized. What mattered was that the compliance box was ticked.

Predictably, not much development happened.

To solve this problem, the amended B-BBEE Codes were introduced in 2013. They ushered in Supplier Development.

Corporations were now required to spend a portion of the 3% (ie 2% of NPAT) on the development of black-owned SMEs from whom they procured goods and services.

The logic was that corporate companies would open market opportunities to SMEs and use the 2% of NPAT contribution to capacitate those SMEs. It was hoped that this would encourage entrepreneurship, increase the number of SMEs, drive economic growth, and ultimately create jobs.

The devil or perverse consequence was however in the details.

In the amended B-BBEE Codes, small businesses were split into two categories to ensure the codes really had a broad-based reach. SMEs with annual turnover below R10 million were categorized as Exempt Micro Enterprises (EMEs), and those between R10m and R50m were labeled as Qualifying Small Enterprises (QSEs).

Corporations are required to spend 15% of their procurement spend with each SME category (30% in total).

For large corporates with billions in annual procurement, this created a serious headache. Corporates struggled to meet the targets and some simply gave up.

Unfortunately, those who succeeded were faced with a dilemma.

Stipulated categories

The SMEs that they developed and gave market opportunities might grow turnover beyond the stipulated categories. If that happened, the corporation would not be able to claim the BEE points they sought in that category.

For example, issuing an EME with a contract for R20m per annum increases the EME’s turnover above the R10m threshold. When this happens, the corporation can no longer claim BEE points on that procurement spend in the EME category.

It thus risks non-compliance despite acting in the true spirit of BEE.

The result is that to maximize B-BBEE compliance, corporates avoid developing SMEs or issuing them with large contracts even when it is feasible.

Consequently, development funds continue to be poured into tick-box programmes that achieve compliance by focusing on endless and unnecessary training of subsistence SME owners. The SMEs only receive small purchase orders designed to keep them as unsustainable “one-man” businesses.

SMEs thus struggle to create quality sustainable jobs and high unemployment has consequently persisted.

As a possible solution, I have previously suggested corporate tax incentives to encourage corporations to issue large long-term contracts to SMEs (Business Report Opinion&Analysis, April 5). Treasury can lean on its years of experience with tax incentives to design a framework that would keep negative unintended consequences to a minimum. In addition to the tax incentives, another amendment should be introduced to the B-BBEE Codes.

The amendment should allow all procurement spend on a contract issued to an EME to be claimed in the EME category for the duration of that contract. This should remain, even if that EME grows turnover above R10m. Equally so with QSEs that grow above R50m.

For example, a corporate entity issuing a 5-year contract of R20m per annum to an EME should be allowed to claim R20m each year in the EME category on its B-BBEE scorecard. This must continue each year over the 5-year period, even though the turnover of that SME would obviously grow above R10m.

This amendment would encourage corporations to issue large long-term contracts to SMEs.

It would then lead to more meaningful SME development, economic stimulation, and accelerated reduction in unemployment and poverty.

To curb the abuse of this amendment, contract extensions should be excluded, so that new SMEs are continuously brought into the fold and developed.

No doubt, there would still be unintended consequences. However, if unemployment and poverty are reduced, the country might be better positioned to handle any resulting challenges.

Karabo Mashugane is the chief executive of 20/20 Insight – Specialists in B-BBEE Advisory, Supplier Development, and SME financing.

The views expressed here are not necessarily those of Independent Media.