Incubation

Before determining how to support incubation, one needs to understand what incubation is. Business incubators are physical and/or virtual facilities that support the development of early stage SMEs through a combination of business development services, funding and access to the physical space necessary to conduct business.

There are three main things to remember when defining incubators: (1) incubators focus on SMEs in the early stages of growth; (2) incubators offer services aimed at strengthening the capacity of SMEs to operate on their own; and (3) incubation is temporary. As Figure 1 illustrates, SMEs in their early stages of growth (idea and pre-seed) have particular needs. Incubators recognise this and target their services to meet these needs so that SMEs can grow independently once incubation ends.

Figure 3: Incubator Focus – Stage of SME Growth

It is important to note that ”early stage” is not a measure of time, but of how much a business has developed. For example, an SME can be five years old, but still struggle to get customers and secure revenues (early stage). At the same time, an SME can be one year old and already be very profitable and financially sustainable (growth stage).

Further, an ”early stage SME” is different from a struggling business that has been started merely to provide a livelihood for its owner. Many people are forced to find their own ways of making a living by starting businesses, many of them informal. While these people may need assistance, incubators are not the organisations to provide it. Incubators focus on entrepreneurs whose businesses were started to grow, not merely survive.

There are many other non-incubator organisations that also aim to “meet SME needs” by using similar services – training, for example. This can create confusion, so here are some examples of the types of things that may look like incubator services, but are not. Among other things, incubators will not:

1.1.1. Offer training other than that required for an entrepreneur to run and grow their own business;
1.1.2. Offer support services indefinitely;
1.1.3. Assist established SMEs that already have secure streams of revenue and customer bases (unless SMEs intend to enter international markets); and
1.1.4. Offer funding only.

It is also important to remember that while incubators are important sources of small business support, they are not the answer to every small business problem. They are only one part of a much larger ecosystem of SME assistance.

Keep the above in mind. As the steps in this document are followed, it is important to maintain a clear idea of what incubation is and what it intends to do.

Incubators address specific market opportunities. Develop a clear idea of exactly what opportunity the incubator will address and which markets or supply chains the incubated SMEs will slot into. This section will explain how to do this.

It is possible to define an incubation opportunity simply as existing when a group of SMEs in a given area require incubation support. For example, if a province has several struggling agriculture-focused SMEs, an agriculture incubator could support them. We might call this a need-driven approach to defining incubation opportunities.

However, a more targeted approach that identifies opportunities for linking SMEs with markets is likely to be more successful. We might call this a market-driven approach to identifying incubation opportunities. A market-driven approach is preferable to a need-driven approach for three reasons:

2.1.1. Without ready markets to sell into, SMEs will have no means of generating revenue and will find it difficult to survive by themselves if they make it through incubation;
2.1.2. The absence of a market may indicate that SMEs are engaging in work that the economy is not suited for; and
2.1.3. The identification of specific markets provides focus and direction to the incubator’s work of preparing SMEs for success.

A market-driven incubation opportunity in a given area arises when three conditions are met:

2.1.4. There is an existing pool of SMEs offering goods or services;
2.1.5. There is an existing market for the goods and services offered by the SMEs; and
2.1.6. There is unmet potential in linking SMEs with markets that incubation can address.

The third point is particularly important. As mentioned, incubation can’t solve every small business problem. Solving some of them will require more than incubation can offer. For example, there may be an incubation opportunity if a business isn’t selling its goods because of a market failure (for example, a lack of information in the market). However, it is unlikely to be an incubation opportunity if it isn’t selling its goods because exchange rate fluctuations are making it too expensive.

To identify a market-driven incubation opportunity, consider the following steps:

Step 1: Identify priority sectors
Provinces and municipalities have a mandate to support certain priority sectors and these should be viewed as a starting point for identifying incubation opportunities:

1.1. Consult internally: Speak with colleagues to identify current areas of focus, for example, sector specialists or Local Economic Development (LED) managers. Further, review the province or municipality’s Integrated Development Plan;
1.2. Identify whether the incubator will focus on strong or vulnerable sectors: Determine whether the sectors identified are a priority because they are (a) performing well, or (b) significant to the economy, but struggling to survive; and
1.3. Narrow sector list: Often, several sectors will be identified as a ‘priority’. Conduct further consultations, including those with industry experts, to further understand which 1-3 sectors represent the most urgent opportunities.

Example: An individual in KwaZulu-Natal is interested in identifying its priority sectors. She consults with an Economic Development manager, who identifies agriculture and tourism as critical sectors. Tourism has experienced strong growth in the province over the last five years; agriculture, however, contributes 20% to the province’s formal employment, but has experienced declining growth over the past five years. There is significant private investment in tourism SMEs, but agriculture is suffering from a lack of investment at all levels. She decides to focus primarily on agriculture.

Step 2: Identify markets
Once priority sectors are identified, the next step is to look at whether they contain viable markets for SME goods and services. For incubated SMEs to be successful, they will need customers to sell to10. This is a particularly important step; see Annexure 1 for more detailed information.

Consider the following steps in identifying markets:

2.1. Identify growing firms: Consult with colleagues, industry experts, academics or civil society actors to identify the major firms involved in priority sectors and which are growing. Growing firms are likely to represent the most promising SME customers;
2.2. Identify ‘upstream’11 industries: This involves understanding the goods and services that the identified firms need to produce their own goods and services. ‘Upstream’ industries provide these. A firm’s supply chain will contain ‘upstream’ industries, for example. Undertake similar consultation as in 2.1;
2.3. Identify ‘downstream’ industries: This involves understanding the processes and services required to transform the identified firm’s goods and services into their final form and deliver them to their final consumers. A furniture manufacturer would be ‘downstream’ of a saw mill, for example. Undertake similar consultation as in 2.1; and
2.4. Identify SME opportunities: Not all identified industries will be appropriate for SMEs. Again, consider consultation as in 2.1 to identify SME opportunities. To qualify as an opportunity for SMEs, the potential good or service should be: small scale; have low capital requirements; and low levels of competition.

Example: Mpumalanga consults one of its economists and identifies that several large paper manufacturing firms have recently been established in the province. After consulting with a local academic, it identifies upstream industries, including timber growing and wood pulping, but most are suited to large firms. One downstream industry, the distribution of paper, seems like an opportunity for SMEs. The manufacturers currently use large trucks to distribute goods to wholesalers, but these are too large to travel to smaller towns and rural areas in the province. Demand in such smaller areas is substantial enough to represent an opportunity for profit for the paper manufacturer.

The figure below further illustrates the above process.

Figure 8: Illustrative Process of Identifying SME Markets

Step 3: Identify SMEs
Knowledge of existing SMEs is key to identifying incubation opportunities. Incubators, after all, need businesses to incubate. Consider the following:

3.1. Consult SME organisations: Try to leverage the networks and expertise of organisations that work with small businesses or relevant sectors in the area, whether these are from academia, the private sector or civil society. Also consider other government initiatives – seda, for example – that may have information on SME distribution in your area;
3.2. Determine whether SMEs are clustered or dispersed: SMEs could be clustered in certain areas or spread out across multiple areas. Their distribution will affect what kinds of opportunities they will be suited for; and
3.3. Draw up a list of SMEs by location and sub-sector: Based on consultations and research, create a list of where SMEs are and in what activities they are engaged.
Example: North West consults internally and discovers that it hosts an initiative that offers grant funding to SMEs in the province. The database of this initiative shows that most SMEs in the province focus on clothing manufacturing, graphic design, logistics and biofuels.

Step 4: Identify potential incubation opportunities
This step involves comparing information on potential markets with information on available SMEs. Essentially, opportunities will exist where: a) there is a match between SMEs and markets in a priority sector; and b) incubation can help bring them together. Consider the following steps:

4.1. Review potential markets considered in Step 2 and Annex 1;
4.2. Review information on SMEs identified in Step 3;
4.3. Identify gaps between identified markets and identified SMEs: Some creativity will be required here. Ways in which existing SMEs can service potential markets may not be immediately obvious; and
4.4. Identify gaps solvable by incubation: Be careful to distinguish gaps between markets and SMEs from gaps between markets and SMEs solvable by incubation. Basically, there needs to be a credible claim that a combination of BDS, physical space and funding will link a group of SMEs to a market they currently cannot access properly.
Example: Limpopo has a potential market in the distribution of paper to rural areas. Clusters of SMEs within the province provide logistical services, many of which are appropriate to the distribution of paper to rural areas.

These SMEs, however, operate at too small a scale and have few vehicles. Two main problems exist: SMEs don’t market their services well and cannot access funding due to a lack of formal business plans. The province determines that these problems could be solved by incubation; specifically, BDS services and
assistance in accessing funding.

If no incubation opportunities have been identified in the area, even after following steps 1.1 to 1.4, resist the urge to create some merely out of a desire for the ‘right’ result. Rather, take the information and insights already gathered and use them to improve other initiatives and policies.

Step 5: Determine existing levels of incubation support in opportunity areas
To avoid duplicating efforts, it is wise to identify what incubation services already exist in your area, whether private or public. Consider the following steps:
5.1. Identify incubators: Consult internally and with key stakeholders and experts involved in the SME sector, as well as the list in Annex 4, to identify incubators in the area;
5.2. Identify incubation-like services: In addition to actual incubators, also identify individuals, organisations and government initiatives that offer incubation-like services – business mentorship, for example. This will help to form a complete idea of what is already out there and how to add to it; and
5.3. Identify gaps: If incubation services exist in the areas in which they are needed, consider if they require strengthening. Certain resources – physical premises, for example – could be lacking.
Example: After an extensive survey, the Northern Cape realises that there are no incubators in the region, but that the local university offers workshops on business development for local SMEs. However, these workshops are infrequent as space at the university is hard to secure.

The Northern Cape decides to collaborate with the university and provides premises for the incubator. The province is able to leverage the educational resources of the university as well as its own assets.

Bear in mind that just because incubation services exist, it does not mean that they should be continued or expanded. The general guidance in Step 4 applies here as well: if there is no credible reason to support existing incubation efforts, even after investigating them, don’t.

Step 6: Identify incubation opportunity
Based on the information gathered during steps 1-5, an appropriate incubation opportunity can now be identified, if one exists.

This opportunity could be:
a. An existing opportunity that is not being served by incubators; or
b. An existing opportunity that is being supported by incubators, but requires additional support to thrive.

If expanding an existing incubator is the right option for the identified opportunity, the first thing that should be done is to review the possible support offered by the dti’s Incubation Support Programme (ISP). Existing incubators can apply for financial support of R10 million per year for a period of three years under the ISP. More information on this is included in Section 4.1.1.

While this handbook does not focus on such expansion, due to it being primarily driven by incubators themselves, it can be facilitated by following these steps:

Step 1: Review incubation opportunity

See Section 2.1.

Step 2: Identify relevant successful incubators

Scan the web or relevant literature for information on existing incubators to identify those whose services match the incubation opportunity and appear to be successful.

Annex 4 of this handbook contains a non-exhaustive list of incubators in South Africa that can act as a starting point. If there are no relevant incubators in this list, consider contacting incubators that operate in a similar sector or area. They may be able to advise on where to go next.

Judging whether the incubators are successful may be more difficult. If an incubator has been identified, again consider reaching out to other incubators involved in similar sectors to get their opinions. Further, review the incubator’s website or publications. Look for some of the following:

a. Clear indicators of success: Incubators with a clear idea of how to track their performance are more likely to be effective in improving it;
b. Clear evidence of success: It is encouraging if incubators present clear evidence or data related to how they are performing according to their indicators of success; and
c. Private sector partnerships: Private sector endorsement, especially if the endorsing firms are actually using the services of the incubated SMEs, is a good indicator that incubation is working.

Example: Gauteng is seeking a biofuels incubator. There is an incubator in the Free State that focuses on renewable energy. Gauteng contacts this incubator, who then directs it to a successful biofuels incubator in Limpopo.

Step 3: Communicate incubation opportunity to incubator
Once there is a clear idea of why the potential incubator will have an opportunity in expanding to the area in question, the opportunity will need to be validated by the incubator itself.

Reach out to the potential incubator via telephone or e-mail to discuss the potential incubation opportunity and whether it is attractive to the incubator. This will not represent a full ‘pitch’, but will rather serve to gauge whether there is any interest in exploring opportunities further. There will likely be multiple rounds of communication as details are discussed and plans made.

Consider tapping into existing networks and contacts that may already be involved with the incubator. This may help ease the process of communication.

Example: A seda branch in Tshwane Municipality has interacted with the incubator the municipality wants to
attract. The seda branch is willing to make introductions; once these are made, the municipality is able to have a telephonic discussion regarding the potential opportunity.
Step 4: Identify levers to create an enabling environment
Much can be done to support the expansion of the identified incubator. Determine what provincial or municipal resources can be offered to incentivise the incubator to expand. Consider things like:

a. Grant funding available;
b. Premises that can be offered at a reduced cost;
c. Linkages with existing SMEs to make outreach easier; and
d. Complementary services, such as BDS offered by a municipality or province.

Inform the incubator of the support available, including that offered by the ISP (see Section 4), during the ongoing discussion process identified in Step 3.

Example: eThekwini Municipality has identified an incubator in Polokwane that it wishes to attract. eThekwini finds out that ISP support is not an option, but has some grant funding available. Further, it can offer premises for the incubator to use at a heavily subsidised rate. This support proves pivotal in securing the incubator’s commitment to expand.

Step 5: Facilitate process and keep promises made
Once buy-in from all parties has been secured, do all that is necessary to ensure that the process of actually establishing the new incubator branch is as easy as possible.
If premises have been promised, make sure they are readily available when needed. If there are administrative procedures to follow, make sure these are as easy as possible for the incubator. Perhaps most importantly, if state funds have been promised to support the incubator’s expansion, ensure they are available when needed.

Consider appointing an individual or small team to take full responsibility for the process of facilitating the incubator’s expansion.