As an engine of growth, jobs and social cohesion, small and medium-sized enterprises (SMEs) receive increasing attention in international policy circles on conflict and development. However, while high on the political agenda, surprisingly little is known about how entrepreneurs themselves experience fragility and how that perception shapes companies’ behaviour and business strategies. This lack of understanding is likely to explain to a significant extent both the persisting shortage of SMEs support and the limited success of SME promotion strategies to date.

The aim of this study is to shed some light onto the ways in which SMEs experience fragility and how they choose to deal with the challenges at hand. It draws on the Netherlands Enterprise Agency’s experience in working with more than 100 SMEs in 10 fragile states, combined with the insights of 48 entrepreneurs and 10 local advisers in Afghanistan, Pakistan, the Democratic Republic of Congo, Sierra Leone and South Sudan. The research findings challenge conventional approaches to SME promotion and stress some core elements that deserve further attention in future research, policy making and programming in the field of SME promotion in the context of fragility.

The core finding of this study confirms an emerging argument in recent literature emphasising the influential role of informal institutions on both business constraints and behaviour. In the absence of functioning or legitimate state institutions and the prevalence of high levels of mistrust – settings that are typically referred to as “fragile environments” – business success hinges to a significant degree on personal and social networks (e.g. family ties or membership of identity groups) as well as on arrangements with non-state governance actors (e.g. traditional leaders or insurgent groups). Such informal arrangements are found to be closely entangled with formal structures. As a result, the readiness to hire employees based on their social background rather than (solely) on experience and merit and the willingness to pay informal protection fees to rebels and government officials largely determine whether an entrepreneur is able to obtain and retain his or her licence to operate, source inputs, secure assets and access markets.

These informal institutional factors are not, however, captured by the widely used Doing Business reports and enterprise surveys. The latter essentially focus on technical constraints, such as access to electricity or finance, which this study unmasks as mere symptoms of deeply entrenched informal arrangements. Access is rarely guaranteed on the basis of formal rules, but rather negotiated on the basis of personal connections or traded in exchange for loyalty or informal fees offered to non-state power holders or government officials.

A second finding of this study is that, although equipped and eager to grow, many SMEs operating in places of insecurity and high risk deliberately deploy coping strategies rather than realising their growth ambitions. This allows them to operate below the radar, minimise exposure to risks and circumvent relations of mistrust. As such, these commonly found coping strategies are likely to differ from the promising investment plan that typically makes an SME qualify as a beneficiary of commercially driven SME support programmes.

A third finding combines elements of the two earlier conclusions: If the structural drivers of business constraints in fragile contexts tend to be ignored and eventually reinforced by conventional donor interventions, these latter bear the risk of reproducing and solidifying the very same structures that cause long-term instability and prevent firms from shifting from a focus on short-term resilience to longer-term growth strategies. At the same time, these findings also suggest that changing existing arrangements in favour of more transparent and inclusive strategies (be it in employment strategies or payment of informal fees) will imply a rupture with the current networks of patronage and inevitably provoke some instability.

Drawing on these findings, the report offers some considerations with a view to translating the insights of local entrepreneurs into more conflict-sensitive SME support strategies for fragile settings. In terms of research, there is a need to: i) explore the multiple ways in which social networks and non-state governance structures have taken on tasks of missing or malfunctioning state structures that now help or hinder SME development; ii) analyse past experience, in which efforts to enhance productivity and expansion of small businesses have yielded limited results and sometimes even exacerbated tensions; iii) and identify promising entry points for de facto business environment reform by studying patterns of SMEs’ reliance and dependency on powerful elite coalitions.

Policy makers in turn will be better equipped to design suitable SME development policies for fragile states if they: i) complement the Doing Business reports and enterprise surveys with political economy analysis as a basis for agenda setting; ii) differentiate between growth and stabilisation objectives and define their target group and strategies accordingly; and iii) embed SME promotion into broader business environment reform that includes non-state actors.

Lastly, the findings of this study suggest that implementing agencies would be well advised to: i) pay particular attention to the role of social networks and non-state actors in their selection, appraisal and implementation procedures; ii) develop tools for SMEs that might not be able to grow in the short term, but that would benefit from support in order to survive and build resilience in the communities in which they operate; and iii) offer technical assistance to encourage conflict-sensitive business operations.