Reviving Thai SME profitability: What are the options?

Small and mediumsized enterprises have been vital drivers of the Thai economy. More than 360,000 enterprises or 99 per cent of the businesses registered in the Kingdom are SMEs, with total revenue of more than Bt10 trillion. 
They are a foundation of the economy because they employ more than 11 million people or 80 per cent of the total labour force, according to a study by TMB Analytics. 
Unfortunately, it’s not easy to survive as a successful SME for the long haul. They constantly have to face fierce competition, fluctuations in commodity prices, and the swings in demand on economic cycles. 
In 2012, the introduction of the Bt300 minimum wage starting from seven main cities had an enormous impact on their costs and squeezed their margins. SMEs’ margins dropped from 2 per cent to 0.4 per cent on average. 
Certainly, the increased minimum wage improved household purchasing power, leading to sales growth of 6.6 per cent, but that could not compensate for the increase in labour costs. According to the Thailand Development Research Institute, some firms saw their labour costs rise by more than 80 per cent because of the wage increase. 
Increasing costs erode SMEs’ margins and destroy their profitability. This is different from corporates. Their margins dropped only slightly, to 2.8 per cent from the previous average of 3 per cent. That implies that minimumwage increases hardly change the profitability structure of a large company.
What drives the gap in profitability between SMEs and corporates? The ability to raise prices and flexibility of cost adjustments are the keys. 
By the economies of scale, corporates are likely to have more bargaining power than SMEs. They might pass on their costs to customers much more easily, or they can better manage higher labour cost by relocating their manufacturing plants to other countries. For example, Nike has relocated its factories from Thailand to Vietnam and Indonesia, which have lower minimum wages, since 2010. 
Meanwhile most SMEs have to stick around in their own country because the cost of relocation cannot be justified.
Simply put, margin is the difference between price and cost per unit. In principle, to increase margin, SMEs need to make this gap as wide as possible, either by increasing prices, making operational improvements and seeking new opportunities, or going into new markets where margins are higher.
The first option is to increase prices. However, buyers’ sensitivity to prices would be a big issue here. SMEs must add more value to their products to make the prices more in line with the customers’ expectations. 
For example, during a labourcost increase in the United States, through direct communication to manipulate customer expectations, Starbucks raised the price of only its lowestmargin product by 1 per cent to persuade customers to purchase products with slightly higher margins because of their better tastes and inherent persona. This strategy improved margins and finally improved net profit by 11 per cent despite of increased labour cost.
The second option is to improve operating processes. This should also enhance agility so that it rapidly responds to competitors and opportunities. For example, a printer firm is facing declining revenues and margins from printed materials. It may find new services by adding ondemand fulfilment services by leveraging on the current resources it as.
Finding a new market is the third option. Market development is a very convincing story to pursue. Instead of delivering products to the current cusฌtomers, SMEs can have an option to sell their existing products or services to new customers in a new region.
Regionalisation matches this interest of SMEs. Especially in the Eastern region of Thailand, urbanisation has grown significantly in the past 10 years because of the manufacturing based in that region’s industrial estates, services from tourism hubs, and border trade associated with Cambodia. 
In the past 10 years, SME growth in this region has been about 8 per cent. Additionally, the average margin of SMEs in the East is 4 per cent, at least three times that in other areas of Thailand. That is why the highest and secondhighest incomes per capita are in Rayong and Chon Buri provinces.
As for the upcoming Eastern Economic Corridor (EEC), this will attract a huge amount for both foreign and local investment, and the market will rapidly expand. At the beginning, corporates will definitely receive beneฌfits from the construction of megaprojects. SMEs can tap this opportunity by joining corporate supply chains, whether subcontractors of construction projects or corporates in industrial estates.  However, after the infrastrucฌture has been built, urbanisation will follow. After that, it will be the time for SMEs’ servicebased industries to prosฌper, especially logistics and hospitality. 
Even though structural changes will come from government policy and lead to margin erosion, there will always be a way to revive it, by SMEs themselves through strategic pricing, revamping operational processes, or pursuing new markets that the government is willing to create for them – such as the EEC. 

Panawat Innurak is assistant vice president at TMB Analytics. He can be reached at [email protected].
Views expressed in this article are those of the author and not necessarily of TMB Bank or its executives.