SME'S Competitiveness Analysis

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SMEs Competitiveness Analysis in Probolinggo East Java Province
Arif Dwi Hartanto
Faculty of Economics and Business
Brawijaya Univerity
arief.pelukis@yahoo.com
Tri Cahyono
Brawijaya Univerity
Narya Ayu Dewani
Brawijaya Univerity
ABSTRACT
The development of SMEs in Indonesia, especially in East Java is very prominent in
creating jobs and reducing poverty. However, there has been high intensity of competition
making the competitiveness is the key for SMEs to guarantee their persistence (sustainability).
Therefore, this study aims to identify the main factors affecting the competitiveness of SMEs.
Outward Looking Approach is used as the basis for the analysis, where the flexibility and
productivity of the business become the main aspect in this approach. Based on interviews of
100 SMEs in food and beverage sector, the results shows that the ability of SMEs in building
effective and efficient network is a determinant for SMEs’ level of flexibility and productivity.
This network is characterized by three conditions, namely (i) the occurrence of operational
efficiency by minimizing transaction costs, (ii) an increase in working capital accessibility, and
(iii) the occurrence of an innovative business climate. This study suggests that the expansion of
efficient and effective network is critical consideration in the development of SME policy.
Field of Research: SMEs, Competitiveness, Business Flexibility, Productivity Business

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1. Introduction
In recent decades, the role of Small and Medium Enterprise (SME) is
increasingly prominent because its contribution to development and economic growth
in many countries has become more vital (Tambunan, 2008; Jiang and Ling, 2009;
Hafsari, 2011; Indrawati, 2012). One of the important indicators can be seen from its
impact to GDP and employment demand. Moreover, recent research also shows that
SME can take a role as a key accelerator in creating and disseminating innovations, as
well as reducing imbalance among regions because of its flexibility in determining the
location of the business that can not be reached by the large-scale industries
(Constantin, 2002; Moore and Manring, 2009; Chittithaworn et.al, 2010; Mura &
Buleca, 2012; Idar et.al, 2012). SME becomes so important because of its role in
creating jobs, maximizing the efficiency of the allocation and distribution by mobilizing
and utilizing local resources, and supporting local economic development
(Cunningham & Rowley; in Idar et.al, 2012; Hendrawan, 2012).
This fact raises a new perspective in seeing the importance of the
entrepreneurship role corralated to economic activities of local talent (local genius) in
developing economy (Swarcz, 2007; Indrawati, 2012). It also corresponds to what J.
Schumpeter stated (Mura& Buleca, 202), that the key factor of economic development
lies in the consistency between macro-economic development theory and the micro-
economic concept about innovative individual entrepreneurship.
Therefore, in recent years, government policy has always been directed
towards capacity building of SMEs focused on the production process which is
increasingly based on science and technology, this is expected to make a significant
contribution in strengthening the domestic economy (Tajuddin, et.al, 2011; Jiang &
Ling 2009). As the implication, SME development policy generally is always oriented to
the increase of production capacity such as technology and innovation.
Even though the development of production is very important, the government
can hardly fulfill the improvement of the institutional aspects such as marketing and
the development of social capital. Whereas, this factor is more essential, it is a basis of
decision-making strategy for SMEs in understanding the characteristics of the market
and competitors, responding customer needs, as well as maintaining sustainability of
the business for long term (Khairuddin, 2008, in Idar et.al, 2012; Jiang and Ling, 2009;
Irjayanti & Azis, 2012). This is consistent with studies of Chittithaworn; et.al (2010) and
Irjayanti & Azis (2012) that lack of capability in gaining market information is a
determinant factor of underdevelopment of SME capacity that impacts on
unsustainability of the business in the intensely competitive market.
To overcome such problem, it is necessary to know the success factor of
competitive strength of the business through managing institutional aspects in order
to succeed in maintaining and developing SMEs for long run. However, most of studies

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only discussed about the competitiveness of the institutional aspects, they focused on
the mechanisms of coordination and network cooperation that can give mutual
benefits. There are still few studies that talked about how institutional mechanisms
can produce effective and efficient business networks implicating to the high flexibility
and productivity of SMEs.
Consequently, the purpose of this paper is to identify and explore
characteristics of a SME network in Probolinggo, East Java that can improve
competitiveness through flexibility and productivity of the business. Once the
identification is found, it can become a reference for policy-making to develop SMEs
through business network expansion strategy. The analytical framework used in this
study is Micro Outward Looking Approach. Micro Outward Looking Approach is a
development concept that emphasizes on the long-term orientation trade sector that
leads out (export).
2. SMEs In Indonesia
There are various opinions in defining SME in Indonesia. Researchers in
Indonesia define SME as business unit that is mostly informal and characterized by
labor intensive. It generally requires small capital to build (Marijan, 2005). While
Pangabean (2007), describes that SME (i) is firm that does not separate the position of
both owner and managerial structure, (ii) uses its own labor, (iii) is unbankable and
used its own capital, (iv) has a low level of entrepreneurship, and mostly does not have
legal status. So the definition of SME is always referring to some of the main
characteristics, namely in the form of assets, sales volume, and number of employees
(Pawitan, 2012). In addition, there are several institutions defining SME such as the
Ministry of Cooperatives and SMEs, the Ministry of Finance, the Central Bureau of
Statistics, as well as some other institutions (Hendrawan, 2012).
Despite the variety of definitions of SME, in outline, it still refers to the populist
business, which then makes SME as a priority sector in making objectives of economic
policy (Tambunan, 2008; Irjayanti & Aziz, 2012; Pawitan, 2012; Wignaraja, 2012). But in
recent empirical studies, the government is still paying less attention to some of the
constraints faced by SMEs, such as (i) policies that are not supportive for the condition
of SME Development, and (ii) inadequate infrastructure (Tambunan, 2008; Siringoringo
et al, 2009; Irjayanti & Azis, 2012; Mourougane, 2012). Besides, there are certainly
some classic obstacles such as limited capital, the quality of raw materials, technology
illiterate and low skill labor (Pawitan, 2012). Other external issues frequently faced by
SMEs in Indonesia are the accessibility of information and intense competition due to
the opening of the free market like ACFTA (Irjayanti & Aziz, 2012; Pawitan, 2012). This
finding is reinforced by Utomo & Dodgson (2001) that the limited access to
information for SMEs in Indonesia is caused by the obstacle in adopting information

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technology due to slow and uneven infrastructure, while the free trade develops so
fast. As impact of this, SMEs: (i) are isolated from market access, (ii) have limited
access to capital, (iii) are hard to reach government’s supports or programs, and (iv)
still rely on the chain factors that are passed from generation to generation with the
very simple product management (Rosid, 2008; Mead and Liedholm, 1998; within
Irjayanti & Aziz, 2012). The various issues implicated to degradation of SME internal
condition, such as management and production innovation. Whereas, in the context of
globalization, one of the key success factors of SME is the application of total quality
management (Lewis, et.al, 2006). This condition is also the reason why the target
markets of SMEs in Indonesia are relatively small and why they are easily defeated by
imported products.
3. Network Management and the Increase of Business Competitiveness
One important aspect of building a powerful business is the quality of the
network (Jiang & Ling, 2009). This network quality indicates that not all networks
implicate to positive things if they do not have the same characteristics of goal
orientation. In a theoretical study, this kind of networks is called alliance, a form of
agreement between the interested party with another party who has the same
orientation. This process stimulates the network members to donate their resources
on new things and generate new values (Huseini & Mamahit, 1994; under Main, 2003).
It is in accordance with what Porter said (1995), that in this concept there are several
activities contributing to the values or services sold to consumers. This process takes
place in the relationship among the firm value chain, supplier value chain, and
distribution (channel) (Main, 2003).
Operationally, the company can take advantage of the relationship (linkage)
through appropriate information systems for optimizing and coordinating every
business activity. As the implication, it will lead to sustainable competition advantage
(Main, 2003; Hutagaol & Feryanto, 2011; Pawitan, 2012). Thus, it can be said that there
is a chain that links the various specific aspects of the value chain of members or
partners consisting of technologies, capabilities (production, marketing, and
management), and product (Main, 2003). This explanation is consistent with Sumarti’s
statment (1978), that the optimal economic activity can not be separated from the
objective aspect of the relationship networks, so that it becomes the basis of social
power.
Furthermore, in the context of free trade, network or alliance becomes very
important because it plays role in the implementation of networking organization. In
some empirical studies, the networking organization implies a significant increase in
the internal capacity of the company. As stated by Barney & Wright (1998), the
implementation of this networking organization can develop a competitive advantage

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by creating value in different way and unique form, or value that can not be imitated
by competitors. In addition, the biggest implications of this networking organization is
that it may also affect the entrepreneurial orientation of its members (Keh, Nguyen
and Ng, 2007; within Pawitan, 2012; Irjayanti & Aziz, 2012). The results of the study of
Wilkinson & Brouthers (2006), in Pawitan (2012), shows the orientations exemplified
here include export orientation that stimulates every entrepreneur to join training and
trade fairs. This resulted in changes of management practice principle, changes of
turnover, changes of market demand, better performance compared to competitors,
and the growth of orientation it self (Setyaningsih, 2012). Thus, in short it can be said
that the quality network has an important role in improving business competitiveness,
especially for SMEs.
4. Research Methodology
4.1. Data
This study was conducted in Probolinggo, especially in the area where the base
SMEs concerning on food and drink commodity as their excellent products are located.
The writer classified SMEs into three sections based on the scale of SMEs, namely (i)
micro SMEs, (ii) small-scale SMEs, and (iii) medium-scale SMEs. The classification was
based on the variable of investment. When it was classified, each scale was identified
to know the level of investment return based on SMEs participating in a business
network and ones that do not participate in a business network.
The data used in this study include primary and secondary data. Primary data
were used to get information from the aspects of production and the business
environment through questionnaires by in-depth interview method, while the
secondary data were obtained from relevant government agencies in the form of data
on the number of SMEs and the quantity of output produced by each SME. A total of
100 SMEs in food and beverage sectors were selected by quota sampling. The variables
listed in the questionnaire questions covering aspects of age of the business,
institutional management, social conditions, facilities and infrastructure, marketing,
capital, labor, technology innovation, ease of acquisition of raw materials, as well as
profitability. This variable is reciprocal to the main qualifications in seeing the business
competitiveness which includes characteristics of SME entrepreneurs, sources and
quantity of raw materials, perception about ease of getting raw materials, amount of
capital, perception about ease of access to capital, marketing capacity, and perception
about ease of access to marketing.
4.2. Method of Analysis
The collected data would be analyzed by using descriptive statistical analysis.
More specifically, the method of analysis used is as follows:

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a. Treatment Effect Analysis
Treatment Effect Model is a method used to know the role of the network
(associations of food & drink SMEs in Probolinggo) in stimulating business
competitiveness. Basically, Treatment Effect model has two equations that are
estimated simultaneously, namely:
,i
c
i
c
i ucWC   ...................................................................................(1)
The equation was used to identify the factors affecting the interests of SMEs to
join the network. The C in the equation is the role of SMEs in the network, while W
includes profitability, access to raw materials, access to capital, and access to markets.
The second equation was used to know the risk level of failure of SMEs, the
model specification is as follows,
ii
cc
i
c
i cCXy  
........................................................................(2)
The y is the risk level of SMEs, the C is participation of SMEs in the business network,
and the X are the factors affecting the level of business risk.
Based on these two equations, it would be known how the role of the business
network reinforces the competitiveness of SMEs in Probolinggo.
b. Analysis of Micro Outward Looking Approach
Looking Outward Micro Approach is a method for detecting operational
process of a company started from growing stage of the business until it gains success,
the analysis Model conducted by using the results of in-depth interviews which include
the two main aspects, namely: (i) aspect of production (including the process of
acquiring inputs, production processes, and output), and (ii) aspect of the business
environment (including the marketing and business management system). In viewing
both aspects, there are at least few aspects that need to be considered including: the
availability of raw materials, capital and marketing aspects.
5. Finding and Discussion
5.1. Statistic Result
In this study, SMEs in Probolinggo were divided into three (3) characteristics
namely: (i) micro-scale SMEs with the number of turnover of less than Rp 10.000.000,
(ii) small-scale SMEs with the number of turnover of between Rp 10.000.000, - Rp
100.000.000, and (iii) medium scale SMEs with turnover more than Rp 100.000.000.
Based on the questionnaire, it was known that the characteristics of SMEs in
Probolinggo based on network membership are like in the following table.

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Table 01. Characteristics of SMEs
Business Scale
Non-Member of
Business Network
Member of Business
Network
Total
Number of
SME
%
Number of
SME
% Total of SME %
Micro (Less than 10 million) 16 30% 12 26% 28 28%
Small (10 to 100 million) 32 59% 23 50% 55 55%
Medium (More than 100
million) 6 11% 11 24% 17 17%
Total 54 100% 46 100% 100 100%
Source: primary data, 2012
Of the 100 respondents, the numbers of micro-scale SMEs are 28%, small-scale
SMEs: 55%, and the rest 17% are medium-scale SMEs. Of the total in this classification,
there are 46 respondents who are members of the business network, in which 26% are
micro SMEs, 50% are small-scale SMEs, and 17% are medium-scale SMEs, While
respondents who did not join the business network totaled 54, in which 30% are micro
SMEs, 59% are small-scale SMEs, and 11% are medium-scale SMEs.
From the previous respondent identity, based on the questionnaires, the writer
can analyze the relationship between the function of the business network and its
relation with the accessibility of business integration. The Business integration is seen
from the accessibility of raw materials, capital accessibility, and market accessibility.
a. Accessibility of Raw Materials
Table 02. Business Network Membership and Access to Raw Materials
Description
Access to Raw Materials
Total
Low Medium High
Number
of SME
%
Number
of SME
%
Number
of SME
%
Number
of SME
%
Non-Member of
Business Network
36 67% 12 22% 6 11% 54 100
Member of Business
Network
1 2% 18 39% 27 59% 46 100
Total 37 37% 30 30% 33 33% 100 100
Based on the findings, table 02 shows that the SMEs that are members of the
business network have high access to raw materials. This is proven by the number of
SMEs that have high access to raw materials at 59%, medium at 39%, and only 2% that
have difficulties in accessing raw materials. This is contrary to the SMEs that are non
members of the business network, that the majority having low access to raw
materials at 67%, medium access at 22%, and only 11% that have high access to raw
materials.

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b. Capital Accessibility
Table 03. Business Network Membership and Capital Accessibility
Description
Capital Accessibility
Total
Low Medium High
Number
of SME
% Number
of SME
%
Number
of SME
%
Number
of SME
%
Non-Member of
Business Network
38 70% 16 30% 0 0% 54 100
Member of Business
Network
5 11% 27 59% 14 30% 46 100
Total 43 43% 43 43% 14 14% 100 100
Based on table 03, SMEs that become members of the business network have
high level of accessibility to capital than non-members. In SMEs joining the business
network, only 11% that have low access to capital, the remaining 59% have medium
access, and 30% have high access. This is very different from SMEs that are non-
members of the business network, which 70% have difficulties in accessing capital,
only 30% that have medium access to capital, even no SMEs that have certainty of
capital accessibility.
c. Market Accessibility
Table 04. Business Network Membership and Market Accessibility
Description
Market Accessibility
Total
Low Medium High
Number
of SME
%
Number
of SME
%
Number
of SME
%
Number
of SME
%
Non-Member of
Business Network 28 52% 11 20% 15 28% 54 100
Member of
Business Network 2 4% 20 43% 24 52% 46 100
Total 30 30% 31 31% 39 39% 100 100
Table 04 illustrates that 52% of SMEs that are non-members of the business
network have a low market access, 20% of the SMEs have medium access, and 28% of
them have high access. It differs from the composition of SMEs that are members of
the business network, in which only 4% that have low market access, 43% that have
medium access to the market, and 52% that have high market access.
In general, when it is viewed from the membership in the business network, it
can be seen that the SMEs joining the business network have the ability to access raw
materials, capital, and markets better than the non-member SMEs. This indicates that

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the participation of SMEs in the business network can support the growth of SMEs,
especially in improving business productivity.
5.2. The role of Network toward Income level of SMEs
Business network is very important in the development of SMEs in Probolinggo.
Corresponding to the estimation results using treatment effect model, it can be seen
some of the factors affecting the interests of SMEs to become members of the
business network.
Equation 1
Description:
C = Participation in Business Network
BB3 = Index of Access to Raw Materials
M3 = Index of Capital Access
P2 = Index of Market Access
Equation 2
Description:
Y = Gross Margin of SMEs
X3 = Length of the Business
BB2 = Proportion of the Need of Raw Materials Coming from Local Region
M4 = Interest Rate
Picture 01. Estimation results of the Roles of Business Network on the Productivity
level of SMEs
Gross margin
of SMEs (Y)
Interest rate
(M4)
Role of
Business
Network(C)
Length of the
Business (X3)
Proportion of
the Need of
Raw Materials
Coming from
Local Region
(BB2)
Index of Market
Access (P2)
Index of Access
to Raw
Materials (BB3)
Index of Capital
Access (M3)

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Based on Picture 01, there are three factors affecting the interests of SMEs to
become members of the business network, namely: (i) index of access to raw
materials, (ii) index of capital access, and (iii) index of market access. Simultaneous
equation results explained that the index of raw materials, capital index, and the index
of market access have a positive effect on the level of productivity of SMEs amounted
to 0.1096, 0.0066, and 0.0206, with an error rate (α) of 5% - 9.99%. This means the
bigger the three indexes, the more interested the SMEs to become members of the
business network. This indicates that the tendency of SMEs to join the business
network is because they expect the network can support them to access raw materials,
capital, and the expansion of market segments.
The important role of the business network in increasing the revenue of SMEs
can be seen from the gross margin (profit), and the gross margin is affected by four (4)
factors, namely: (i) interest rate, (ii) length of the business, (iii) the proportion of need
of the raw materials coming from local region, and (iv) the role of business network. Of
these four factors, the interest rate has no significant effect due to its error rate (α) of
10% - 15%. So there are three factors that significantly affect gross margin; the first is
length of the business that has negative impact of -489.070 with an error rate (α) of 5%
- 9.99%. This means that the longer the age of SMEs, the more decreased the rate of
profit. This phenomenon indicates that the SMEs are not growing, even though the age
of the business is long enough. The second is the proportion of the need of raw
materials coming from local region, it has negative effect of -176,137 with an error rate
(α) of 1% - 5%. That is, the greater the SMEs take raw materials from the local region,
the more decreased the gross margin. This indicates lack of the development of micro
and small scale SMEs because the need to produce is very low, so they took a supply of
raw materials from the local region. The third, the role of business network has a
positive effect for 38,400,000 with an error rate (α) of less than 1%. This signifies that
when SMEs join a business network, their profit tends to increase.
Thus, it can be stated that the impact of the business network is a determinant
factor of the profitability level of SMEs in Probolinggo. High level of profitability
reflects high productivity. The profitability level is also a determinant of the
competitiveness of SMEs, as the high profitability can stimulate companies to invest in
research, development and innovation (Chittithaworn, et.al, 2010). Such condition can
help SMEs in providing the best value for their customers and differentiate them from
their competitors (Pawitan, 2012).
The influence of business network to the level of profitability of SMEs in
Probolinggo can be indicated by the level of Return on Investment (ROI). When the ROI
level is gained rapidly while the level of competition is high, it means the company can
overcome the competition problem, and vice versa. It also can be said that the high
level of ROI reflects the efficiency of production costs and transaction costs.

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Picture 02. The development level of ROI Based on Development of Business Scale on
Network-Member SMEs and Non-Network-Member SMEs in Probolinggo.
0
0,5
1
1,5
2
2,5
3
3,5
4
4,5
5
Micro Small Medium
Members of Business
Network
Sources: Processed Data, from Disperindag East Java,2011
Picture 02 shows that the SMEs that are members of business network have
increasing levels of ROI. That is, the larger the development of business scale, the
higher the ROI level. Thus, the development of SME scale is positively related to the
profitability development of SMEs, so that the business can be run efficiently. In
contrast, for SMEs that are non-members of the business network, the ROI level tends
to be declining and constant. This indicates that the development of SME Scale is not
balanced by the level of profitability development, which means the business
operation does not run efficiently.
5.3. The Benefits of Network for SME Competitiveness
Benefits of the network can be known through their functions for business
sustainabilty of the members (Wignaraja, 2012). This sustainability can be seen
through the level of accessibility of members in the network that includes business
integration which are input, process and output (Jiang & Ling, 2009). Benefit of this
continuous accessibility can be indicated from the level of profitability the members
can get (Resmi, 2011).
If we see the result of the study, it suggests that the role of business network
has a significant effect on the profitability of SMEs in Probolinggo, and The profitability
indicates the productivity of the business. In addition, from the calculation of ROI, the
SMEs in Probolinggo that join the business network also have a high level flexibility in
business. This is indicated by the ROI increasing rate that was positively related to the
development of business scale. So it can be said when the business scale increases, the
SMEs are more flexible in responding to market demand. Therefore, the business

12
network in Probolinggo has benefits for business sustainability of its members. It can
be traced from several key factors including:
1. Business efficiency by minimizing the transaction costs
In general, transaction costs that often arise in SMEs are (Yustika, 2008): (i) cost
of searching information, (ii) cost of producing, contract enforcement, and monitoring
contract (iii) cost of waiting during the production time, (iv) management fees, and (v)
cost of distribution.
In fact, before the business network was built, the members were very difficult
to find information, especially Information about raw material (input) and how to
market the products with suitable prices. Without such information, most of the SMEs
can be the victim of asymmetric information that tends to harm the development of
their business for long-term.
when the network was built, there was cohesive information in the partnership
contract between the SMEs and the input provider or the output user. This is done in
order to make the business run well and sustain. the partnership contract can
guarantee or support SMEs to sustain for long term. This is evidenced by the reduction
in transaction costs of each network member. The transaction costs are mostly used
for improving business management, distributing input and output, and transportation
costs.
2. Increasing the accessibility of working capital
Before joining the business network, the accessibility to capital for SMEs is very
low, in terms of initial capital mobilization (start-up capital) and access to long-term
working capital for investment. For the initial capital mobilization, the functions of
business network involves three aspects, namely financial assistance, technical
assistance, and assurance program. Meanwhile, to improve access to capital it needs
the role of other members in providing loans to members in need. This is done in order
to help members that have limited access to bank credit. This is kind of social
insurance provided among the fellow members of the network.
3. Creating an innovative business environment
Before joining the network, Most of the SMEs managed their product
traditionally or manually. However, after participating in the network, SMEs gets easier
in marketing, technology, information access, entrepreneurship preparation, gaining
capital, and other benefits. This will encourage the development of marketing, better
product management (production), and more attractive product packaging.
6. Conclusion and Recommendation
Based on the analysis by using Micro Outward Looking Approach, some of the
functions of the business network are to cover the internal and external problems. This

13
internal problems happen due to poor business management. Some of the main
internal problems of SMEs before joining the business network can be classified into
five aspects, namely: (i) financial management issue, (ii) difficulty in accessing labor,
(iii) difficulty in managing raw materials, (iv) difficulty in managing quality & quantity
control, and (v) cultural issues of the entrepreneurs relating to entrepreneurial spirit.
While for external problems, there are several factors that affect the problem,
including: (i) institutional aspects, (ii) the socio-politics, (iii) infrastructure, and
(iv) marketing.
In the analysis of growth and development, the business network has benefits
in some product innovation and marketing expansion, strategies in business are aimed
to improve product quality in order to compete in the broader market, and expansion
functionates in strengthening and improving product quality and innovation. Resmi
(2011) explained, a good quality product is the product that can meet the needs and
exceed the expectations of consumers, and it can fulfill the dimensions of quality in
terms of performance, features, reliability, conformation, durability, service ability,
aesthetics, and perceived quality. The dimensions of quality for service can be
measured from: direct evidence (tangibles), empathy, reliability, responsiveness, and
assurance. When the aspects in micro outward looking aspect model can be catered,
then the implications for the flexibility and productivity of SMEs can be run well and
can be perpetuated in the long run.
From the previous conclusions, the important role of the network is its function
in improving the accessibility of the network members in the supply of raw materials,
capital and market expansion. Because this function is very important, the network
needs to be managed by professionals who have the entrepreneurial spirit, so as the
network can develop its link to get suppliers of raw materials, the owner of capital, as
well as business participants widely. It is expected that the business network is not the
forum for the opportunists who is just seeking rent, especially, the government's aid
hunters that are covertly using development programs as their modus. Moreover,
because there are some differences of fundamental problems faced by SMEs either
micro, small, and medium business, the development of the business network should
be tailored to the specific needs of SMEs, such as the expansion of market for micro
and small SMEs. Through this action, it is expected that the interest of SMEs to
participate in the business network increases. Coaching and the network
empowerment should not be conducted based on the principle of equality but the
principle of the needs of its members. So that the activities of the network are diverse.

14
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