The private manufacturing sector in Cambodia: a survey of 63 firms

36745 PRIVATE SECTOR DISCUSSION No. 11 The Private Manufacturing Sector in Cambodia: A SURVEY OF 63 FIRMS Leila Webster Don Boring November 2000 i  ACRONYMS ASEAN - Association of Southeast Asian Nations CMT - Cut, Make, Trim FDI - Foreign Direct Investment FOB - Freight on Board GDP - Gross Domestic Product MPDF - Mekong Project Development Facility ODA - Official Development Aid ii  TABLE OF CONTENTS INTRODUCTION ....................................................................................................................................V I. SURVEY OBJECTIVES AND METHODOLOGY......................................................................1 A. OBJECTIVES......................................................................................................................................1 B. METHODOLOGY................................................................................................................................1 II. COUNTRY CONTEXT................................................................................................................6 A. A BRIEF HISTORY.............................................................................................................................6 B. THE CAMBODIAN ECONOMY TODAY...............................................................................................7 C. THE CAMBODIAN PRIVATE MANUFACTURING SECTOR...................................................................9 III. THE MANAGERS ......................................................................................................................11 A. GENERAL CHARACTERISTICS.........................................................................................................11 B. MOTIVATION AND PERSONAL QUALITIES......................................................................................12 C. POLITICAL CONNECTIONS AND CORRUPTION ................................................................................12 IV. THE FIRMS.................................................................................................................................14 A. GENERAL CHARACTERISTICS.........................................................................................................14 B. LABOR ............................................................................................................................................16 C. FINANCE .........................................................................................................................................18 D. PHYSICAL CAPITAL ........................................................................................................................20 E. PRODUCTS AND MARKETS .............................................................................................................21 F. PERFORMANCE ...............................................................................................................................23 V. FINDINGS AND CONCLUSIONS ...............................................................................................24 A. WHAT WE HAVE LEARNED: SUMMING UP....................................................................................25 B. LOOKING AHEAD............................................................................................................................27 VI. BIBLIOGRAPHY........................................................................................................................29 iii  FIGURES Figure 1.1: Distribution of Sample by Industry.................................................................... Figure 4.1: Sample Firms' Dates of Registration................................................................. Figure 4.2: Demand for Short-Term and Long-Term Loans................................................ Figure 4.3: Output Markets for Sample Firms..................................................................... TABLES Table 2.1: Gross Domestic Product.................................................................................... Table 2.2: Trade Balance.................................................................................................... Table 3.1: Professional Background of Sample Managers................................................. Table 3.2: Previous Production Experience of Sample Managers..................................... Table 4.1: Average Annual Labor Growth Rates for Sample Firms, Since Registration... Table 4.2: Sample Firms and Loan Applications................................................................ BOXES Box 2.1: Case Study--The Cost of Poor Infrastructure................................................... Box 4.1: Top Problems Cited by Managers..................................................................... Box 4.2: Case Study--The Cost of Poor Relations Between Banks and Private Firms... Box 4.3: The Internet........................................................................................................ Box 4.4: Trade Association Membership......................................................................... Box 4.5: Case Study--The Cost of Weak Enforcement.................................................... Box 4.6: Mini-Analysis--Winners vs. the Rest................................................................. iv  INTRODUCTION This report advocates the position that local entrepreneurship and initiative are the fundamental underpinnings of sustained economic rehabilitation and development in Cambodia. In so doing, it seeks to balance alternative arguments that place external resources such as overseas development aid (ODA) and foreign direct investment (FDI) as the key determinants of Cambodia's economic future. The report presents the findings of a survey of some of Cambodia's most successful domestic entrepreneurs and addresses how well prepared they are for competition on a global scale and what means should be used to support their further growth. The domestic private manufacturing sector described in this report is quite young. Still, it has already taken significant strides and shown its potential to make significant contributions in major areas of concern for national economic policy makers. Particularly noteworthy given Cambodia's rapidly growing work force is the average per firm labor growth rate of 25 percent a year seen over the short lives of sample firms. Such accomplishments are particularly impressive when put in the context of Cambodia's ongoing transitions to political calm and a market economy, wherein business support services are scarce and the business environment still suffers from lack of transparency and predictability. The global marketplace, of course, will not make exceptions for Cambodia because of its past. With the government committed to greater stability and openness to the world, Cambodian business is set for inevitable and substantial change. In particular, domestic firms are clearly set to experience a significant rise in competitive pressures. Cambodia's first wave of entrepreneurial pioneers has shown great ingenuity and perseverance in succeeding in the difficult present environment. There is, therefore, good reason for optimism that, given fair access to basic commercial resources, they and those soon to follow will continue to adapt and broaden their success within the evolving framework of a more global, rules-based market. v  I. SURVEY OBJECTIVES AND METHODOLOGY A. Objectives 1.01 Based on the assumption that local entrepreneurs are central to any effort to significantly contribute to Cambodia's sustainable economic development, this survey report has three primary objectives: (i) to document the current status, opportunities, and constraints of the domestic private manufacturing sector; (ii) to identify opportunities and constraints that can be addressed by government, donors, and the private sector itself; and (iii) to identify specific opportunities for MPDF programming to directly assist individual private sector firms with viable investment plans and, more generally, to strengthen the full range of business support services available to the entire domestic private sector. B. Methodology 1.02 The Approach. The survey concentrated exclusively on companies that: (i) have 20 or more employees; (ii) are formally registered with the government; (iii) are located in the greater Phnom Penh area1; (iv) operate in the manufacturing industry; and (v) are majority owned by private individuals of Cambodian nationality. The goal was to interview a total of 100 firms. 1.03 Sample firms were limited to those with 20 or more employees for two main reasons. First, these larger firms were deemed best qualified to offer key insights on the prerequisites for success in Cambodia's current business environment. Size itself, to a significant extent, is a measure of success; and in Cambodia's young private sector, firms with 20 employees or more are indeed relatively large.2 Second, most MPDF services are tailored for a category of enterprises that, while labeled small- and medium-sized, is still significantly larger than the average-sized private Cambodian firm. Focusing on larger firms also had practical research benefits, as nearly all firms in the defined group could be identified, whereas doing the same for the entire private enterprise sector was not feasible. 1.04 The legal registration criterion was designed to focus attention on the firms most important to future economic growth and job creation. It is well documented in many developing countries that informal sectors are invaluable sources of income generation, particularly for low-income and marginal groups, but informal sector contribution to overall economic growth is limited. Informal sectors are relatively inefficient producers of goods due to their small size and are rarely sources of significant creation of new, salaried jobs as few ever grow large enough to hire even one paid employee. Additionally, legal registration is a prerequisite for numerous key factors behind firm-level expansion, including formal bank lending.3 1 The greater Phnom Penh area was defined as a the city proper, plus a surrounding area extending up to 30 km away from the city. 2 MPDF used a higher minimum cutoff of 100 employees for its survey of larger manufacturers in Vietnam, considering that country's greater number of large domestic private firms. See Vietnam's Undersized Engine, A Survey of 95 Private Manufacturers by Leila Webster and Markus Taussig, MPDF Discussion Paper #8, June 1999. 3 Many sample firms had registered locally but not nationally, i.e., with the communal or district authority prior to full registration with a national ministry even though the current law specifies that registration with the relevant national ministry is all that is required. Incentives to stall the full registration process, such as partial shielding from potential taxation, sometimes motivate manufacturers to delay the process as long as possible. As firms grow, 1  1.05 Limiting the geographic scope of the survey to the greater Phnom Penh area reflected the fact that while only about 18 percent of Cambodia's population resides in or near the city, the manufacturing industry is centered in Phnom Penh. This is in large part due to the area's superior infrastructure and disproportionately large share of national buying power.4 The geographic limitation also had a practical cost/benefit advantage: time and money spent would be much higher for reaching individual companies outside the general area of the capital, while the number and size of such firms appeared to be quite small. 1.06 The survey focused only on manufacturers because it is these firms that typically invest the most of their own capital and thus assume the greatest financial risk. Manufacturers also tend to be labor-intensive, in keeping with Cambodia's comparative advantage in low-cost labor. While agriculture is sure to remain the country's main employer for a long time to come, manufacturing is likely to be an important creator of much-needed new, salaried jobs for Cambodia's young population. These will generally be higher value-added and, as a result, higher wage jobs than those in primary agriculture. MPDF's own experience has also concentrated largely on the manufacturing sector. 1.07 Finally, the survey was limited to firms with majority private Cambodian ownership. Unlike in neighboring Vietnam, manufacturing is almost entirely privatized in Cambodia.5 And while foreign investment in manufacturing grew in significance over much of the 1990s, ultimately it will be domestic entrepreneurs who propel the economy forward, employ large numbers of Cambodians, and build the foundation of a viable tax base.6 Ultimately, the majority private, domestic ownership criterion also reflects the MPDF's own guiding mandate for action. 1.08 The Survey Population. A single, comprehensive database of registered companies is not yet available in Cambodia. A list of firms in the defined target group was created by combining MPDF's in-house list of companies with additional directories compiled by the Ministry of Commerce, Ministry of Finance, and other official government sources.7 Data from different sources was merged, filtered for duplication, and then each firm was contacted to verify it was still in operation and fit it becomes beneficial to complete the process and become a fully licensed company. The impetus to complete the registration process is provided by such factors as access to government contracts, theoretical protection from petty graft at district or commune level, potential access to bank loans, and the right to import raw materials and export manufactured products. 4 Statistics on GDP distribution by region was not available at the time of this report. For population statistics, see "General Population Census of Cambodia 1998, Final Census Results" p. 9. The municipality of Phnom Penh had a reported population of 999,804--or 9% of the nation's total. The Province of Kandal, which surrounds Phnom Penh, had a reported population of 1,075,125--also 9% of the nation's total. The districts of Takmau, Kien Svay, Kandal Steung, and Khsach Kandal, the most densely populated of Kandal Province, are economic suburbs of Phnom Penh. Combined, the population of Phnom Penh and Kandal Province is 2,074,929--18% of the nation's total inhabitants. 5 Official statistics on state and private shares of the economy are unavailable in Cambodia. Drawing on lessons in other countries, the government has decided that state firms cannot be relied on as potential leaders of future growth because of their well-documented low levels of efficiency. 6 After climbing to US$854 million in 1998, foreign investment approved in 1999 actually fell to US471.7 in 1999, due to political instability. The government target for 2000 is US$500 million (EIU Country Report Cambodia-- August 2000, p. 12 of 16). It is also worth noting that a significant amount of foreign investment up until now has been of a short-term and fairly speculative nature. 7 Additional sources included Council for the Development of Cambodia, Ministry of Interior, Ministry of Social Affairs, Labor, Vocational Training and Youth Rehabilitation. 2  survey selection criteria. The final database of target group firms consisted of 145 companies. As explained below, however, most of the 63 firms in the final sample did not come from this database.8 1.09 Sample Selection. All 145 target group companies were sent a letter explaining the survey's objectives, requesting an interview, and promising a copy of the final report. Letters were then followed up with direct telephone calls to firm managers. In many cases, contacts in the government or business community intervened to convince individual managers of the value of establishing a relationship with MPDF through participation in the survey. Still, this process yielded interviews with only 23 firms. 1.10 Alternative means were used after it became clear that the database would not produce a sufficient number of firms. Seven firms agreed to participate after being introduced by MPDF staff and 14 after being introduced by local consultants who were paid per firm referral. Another three interviews were secured through newspaper advertisements.9 Finally, MPDF resorted to directly approaching firms that appeared on sight to meet survey criteria. In those cases where companies indeed did qualify, the purpose of the survey was explained and an interview requested. This latter method proved highly successful and in the end accounted for 16 of the firms included in the sample. 1.11 Given the relatively small number of firms that actually fit target group criteria as well as the significant number unwilling to participate, the final sample of 63 surveyed manufacturers was not randomly selected and may represent certain biases. Surveyed firms could be assumed to be, on average, more open-minded and optimistic about the benefits of contact with external parties than their peers who declined to participate. On the other hand, the latter group may not have felt any need for outside assistance. In any case, while the final group of 63 fell short of the targeted 100, it still did represent a significant share of total qualified target firms and allowed for findings that reflect the general state of the private sector. 1.12 The final sample represented a diverse group of manufacturers ranging in size from 20 employees to 1,000 and across a wide variety of industries (see below). With few exceptions, all business operations--production, sales, storage, and management--were conducted at a single site. Facilities ranged from large garment factories equipped with modern, imported machinery to a small inner-tube manufacturer operating out of a wooden building with a dirt floor. Most firms openly displayed signs and lights denoting the location as a business. 1.13 A quarter of sample firms were in the non-metallic products sector, i.e. produced construction materials such as bricks and tiles. Twenty percent were food and beverage businesses--including water bottlers and rice millers--and the 8That so many firms were found that were not in government databases reflects the reality that government has very limited information about the private manufacturing sector. This lack of communication clearly has implications for the government's ability to implement good public policy. 9 A newspaper advertisement was published in Phnom Penh's most prominent local newspaper Resmei Kampuchea for three consecutive days. It provided a basic explanation of the survey, a list of company criteria, and offered firms and individuals US$10 for a successful interview. The same offer was made to individuals acting as freelance scouts looking for eligible firms. 3  remaining 55 percent were fairly thinly spread across garments, plastic goods, pharmaceuticals, metal, wood, and paper products.10 Figure 1.1: Distribution of Sample by Industry Non-met alic Products 25% Food &Beverage 20% Wearing Apparel 13% Rubber &P lastic Products 9% Fabricated Metal 8% Chemical Products 8% Furniture 6% Wood Products 3% P rint ing 3% 2% Tabacco Paper Products 2% 1.14 The Questionnaire. The survey questionnaire was based on one used by MPDF for a comparable exercise carried out in Vietnam.11 It comprises 185 questions covering issues about: (i) the manager's background and current status; (ii) the firm's labor force, access to and use of capital, and main sources of markets, inputs, and competition; (iii) the business environment; (iv) the firm's relations with government; and (v) the main constraints to firm-level growth. 1.15 Implementation. Survey teams interviewed the 63 sample firms between December 6 and December 24, 1999. Interviews were conducted by two person teams.12 Interviews typically lasted approximately three hours and were conducted on-site with the company owner.13 1.16 Data Processing. Statistical software was used to calculate means, medians, and ranges for continuous variables and frequencies for discrete variables. Open- ended, qualitative answers were sorted using basic word processing software. 1.17 As a second step, a series of "mini-analyses" were designed to reveal trends in the data. Specifically, these sought to answer two related questions: (i) first, what were the main predictors of firm-level performance, i.e. what kinds of firms were performing best at the time of the survey; and (ii) second, what were the main predictors of firm-level access to resources, in particular to formal bank credit. Six 10 MPDF was unable to access either regional or national statistics from any official sources on sectoral distribution of firms within manufacturing. 11Questions from a survey tool used by MPDF in Vietnam were re-tooled for the Cambodian context. See Webster and Taussig, June 1999 and A Survey of Medium and Large Private Companies in Lao PDR by Leila Webster and Pat Dye, MPDF Discussion Paper #2, March 1998. These also built on earlier survey work by Ms. Webster in the transitional economies of Eastern Europe and the Middle East. 12 Each team consisted of a foreigner with extensive international business development experience and one Cambodian who provided local knowledge and undertook the difficult task of effective translation. 13 The majority of interviewees were conducted with each firm's primary owner/manager. In a few cases, interviewees were other management-level employees or majority shareholders with intimate knowledge of the company and the owner. Interviewees are referred to throughout the report as managers. 4  variables were hypothesized to be predictive of firm performance and access to resources. These were date of registration, number of full-time employees, employee growth rate, exporters vs. non-exporters, manager's ethnicity, and manager's previous employment. A seventh variable, identifying firms as either "winners" or "the rest", was created by combining a series of answers to questions addressing trends in sales and profits. The most interesting results of this analysis are presented in a "Mini- analysis" box in Chapter IV. 5  II. COUNTRY CONTEXT A. A Brief History 2.01 The current state of Cambodia's economy and private sector must be seen in the context of the country's still-ongoing transition from centrally planned to market economy and evolution from protracted civil war to post-war reconstruction and stability. Only since the mid-1990s has a fledgling manufacturing base begun to emerge, diversifying the long stunted economy away from a traditional dependence on agriculture. A quick summary of Cambodia's history offers insights into why local manufacturing has been so slow to develop. 2.02 Cambodia was colonized in 1863 by the French, who claimed the move necessary to protect the flank of Cochinchina from Siamese aggression. French colonial control lasted 90 years until 1954, with a brief break in 1945 when Japanese forces named a young King Norodom Sihanouk as the country's nominal leader. Manufacturing during this time was minimal, limited mostly to rice processing and rubber. Most profits from both of these two industries went into foreign hands, either through direct ownership or heavy colonial taxes.14 2.03 Following 1954 multi-party peace talks in Geneva and French withdrawal from Southeast Asia, King Sihanouk abdicated his throne and led his own political party, the Sangkum Reastr Niyum, to electoral victory. Under Sihanouk, Cambodia tried to maintain a precarious balance of political neutrality, even as the growing war in Vietnam gradually spilled over the border. Increasing instability severely constrained business development. Meanwhile, even though Cambodia had taken control of judicial, military, and diplomatic affairs, control over imports and exports, including the lucrative rubber trade, remained largely in the hands of French merchants.15 2.04 In 1970, Sihanouk was overthrown in a coup by Lon Nol, ostensibly to re- establish a modicum of stability through reassertion of Cambodian sovereignty over territories lost to Khmer Rouge or Vietnamese control. As the government in fact progressively lost sovereignty over greater and greater parts of the country and fighting further intensified, Cambodia became almost completely dependent on American aid and manufacturing activity ground to a halt.16 2.05 Khmer Rouge forces captured Phnom Penh and created Democratic Kampuchea in April 1975. For the next 44 months Cambodia was governed by the Pol Pot regime, which systematically and completely dismantled the economy, with the stated aim of establishing an agrarian utopia. The result of this strategy was economic chaos and starvation. 2.06 With the assistance of Vietnamese forces, a rebel faction of Khmer Rouge leaders, led by Heng Samrin and Hun Sen, overthrew Pol Pot in 1979 and established the People's Republic of Kampuchea. This prompted an outflow of ethnic Chinese-- traditionally Cambodia's merchants and manufacturers--who feared hostility from 14Chandler, "A History of Cambodia" pp. 138-142 15Chandler, A History of Cambodia" p. 186 16Shawcross, " Sideshow, Kissinger, Nixon and the Destruction of Cambodia" p. 183 6  the new regime.17 To a certain extent, ethnic Chinese merchants were replaced by immigrant merchants from Vietnam. For much of the decade, civil war with the Khmer Rouge continued, keeping the country in a constant unpredictable, martial- law-type state and stunting general economic development. Still, under the new leadership, small-scale manufacturing did re-emerge--paralleling the evolving Vietnamese system built around state-owned enterprises and cooperatives.18 2.07 Upon withdrawal of Vietnamese troops in 1989, a coalition of domestic factions began governing the country as the State of Cambodia. Large numbers of Vietnamese merchants and tradesmen left along with Vietnamese troops, allowing local entrepreneurs to fill the vacuum.19 2.08 The United Nations Transitional Authority in Cambodia (UNTAC) was established in 1991 and began pushing for national elections and democratically- elected government. Political stability was slow to come in the renamed Kingdom of Cambodia, as factional infighting prevented creation of a predictable, rule-based business environment. Political infighting came to a head in June 1997, leading to a chill in relations between foreign donors and the government. Donors and the government reinvigorated cooperative efforts following a new round of elections in July 1998 that re-established Hun Sen's Cambodian People's Party as the head of a coalition government. The subsequent December 1998 acceptance of Cambodia into the Association of Southeast Asian Nations (ASEAN) ushered in a period that has so far been characterized by political calm and economic promise. B. The Cambodian Economy Today 2.09 While an embryonic legal system and inadequate infrastructure present challenges that should not be underestimated, there are very real reasons for optimism about Cambodia's current economic picture. Among these: (i) many of the core laws and policies that underpin any market system are now in place; (ii) the government is pro-business in its general approach20; and (iii) there is a growing sense of long-term political stability that should encourage investment. It is notable that, with the exception of Thailand, Cambodia is in fact the first nation in the Mekong region to officially commit itself fully to a free market system.21 2.11 Cambodia's economic prospects have brightened considerably in the past two years.22 Economic growth recovered in 1999 to four percent, and should continue this year and next at a higher rate of about six percent. The Cambodian currency, the riel, 17Chandler, "A History of Cambodia" p 229. 18As in Vietnam, inefficiencies in the state sector left a limited space--one that fluctuated in size with the political mood of the day--that was filled by informal private enterprise. This space grew somewhat in the late 1980s, again paralleling the evolving economic system in Vietnam (Webster and Taussig, pp. 10-11, 86-89). 19Desbarats, "Prolific Survivors, Population Change in Cambodia 1975