Starting small: Entrepreneurship is common, but greater support would spur growth

There is growing interest across Mexico in innovation and entrepreneurship, and in how they can contribute to raising the country’s levels of productivity, employment and economic growth. However, a review of what is happening in the country in this important space must be undertaken in two parts. The first involves the acknowledgment that as a developing economy Mexico faces serious structural problems, some of which pose real obstacles and significant challenges to the kind of innovation and entrepreneurship that is desired. The other is much more encouraging: there are real signs that limitations are being pushed back and that new approaches are beginning to gain traction.

Mexico is clearly at a stage when innovation matters. According to the World Economic Forum (WEF), emerging economies go through three main growth stages. In stage one, growth is factor driven (primarily by unskilled labour and natural resources); in stage two, wages rise and growth becomes more efficiency driven, with factors like the quality of education and human resources becoming more significant. In stage three, growth in developed economies becomes increasingly dependent on innovation, and in particular the ability to create new products and production processes.

Challenging Categories

The WEF has placed Latin American economies into this framework: Mexico, along with Brazil, Chile and Panama, among others, is considered to be in a “transition phase” between stage two and stage three. In other words, from a formal point of view, innovation can help accelerate economic growth. However, the academic literature and a series of practical observations highlight a number of concerns. In developed economies new ideas often come from self-employed entrepreneurs and from small and medium-sized businesses. Roughly 6.1% of the economically active population in the US is self-employed. The average for Latin America is much higher, at 28.7%, but while self-employment in the US and other developed economies is often a choice, associated with entrepreneurship, in Latin America it is more regularly a decision taken for lack of alternatives, which tends to trap many people in low-paid occupations that do not enable them to become future innovators.

According to a study by the World Bank, “Firms in the region suffer from a chronic and substantial innovation gap relative to comparator counties and regions.” They launch fewer products and register fewer patents than their international peers, and tend to grow slowly. The study found that Latin American and Caribbean companies that had been operating for 40 years or more tended to be on average one-third of the size of similarly aged companies in Indonesia, Malaysia, the Philippines and Thailand. Companies in the region were 20% less likely to have introduced a new product than their peers in Eastern Europe and Central Asia.

The study also identified other related issues stunting the growth of small and medium-sized companies, such as poor-quality education, high logistics costs, and high telecoms and broadband internet costs, all of which are relevant for Mexico.

Financial Ecosystem

The country has been relatively slow to build a financial system that supports start-ups and entrepreneurs. In recent years advanced economies have built an ecosystem around start-ups, including support at different stages of their growth cycle, ranging from angel investors to incubators and venture capitalists. A Mexican version of that ecosystem is only now beginning to emerge.

Initially, perhaps too much emphasis was placed on purely academic research and development, and the first incubators were run as university courses to train people to produce generic business plans, rather than help launch real start-ups.

Rodrigo Gallegos, technology director at the think tank Instituto Mexicano para la Competividad, has commented that there has been a kind of cultural divide between the academic and business worlds in Mexico. In his view, some 70% of research and development spending has been in the academic sector and 30% in the business sector, while in the rest of the world those proportions are now the other way round. He also noted that, “A number of our business people are quite comfortable getting a reasonable rate of return in traditional business sectors, we don’t see enough of them looking at new ventures and new ways of doing things.”

Yet things are changing. Gabriel Charles, who runs Wayra Mexico, a Mexico City-based incubator for start-ups backed by Telefónica of Spain, said the main components of a start-up ecosystem are now falling into place. Wayra Mexico supports 10 start-ups a year, investing $100,000 in each. He argues that a new generation of innovative firms is beginning to tackle some of the problems that traditional companies or governments have been unable to resolve, such as unequal distribution of income and narrow markets. “The three Mexicos – the Mexico of extreme poverty, the Mexico of oligopolies, and then the entrepreneurial, high-tech Mexico – can all come together through the internet. Companies in all sectors can be transformed using digital production systems,” he told OBG.

Staying Mobile

Charles noted that Mexico remains under-banked, with almost half the population working in the informal labour market (outside the tax and benefits system), and unable to open a bank account or to receive credit. Some start-ups are reaching out to these potential customers in innovative ways.

According to Charles, microfinance companies are working through mobile phones. “Right now 90% of Mexican mobile phones use prepaid credit, and you can purchase credit top-ups almost everywhere. So there are companies that are lending mobile phone credit or airtime by text message, for a small charge, paid back at the time of the next top-up,” Charles told OBG. “It is a type of micro-credit and it reaches people who as far as the banks are concerned, don’t have a credit history and cannot be bank customers. The telco companies, however, know their prepaid credit history and can manage risk accordingly.” Charles also detects a change in the thinking of some of Mexico’s traditional, family-run companies. He said that some of those families tended to “bury their money in the ground”, meaning that they invested excess capital in real estate. But as he put it, “The next generation in those families realises that they have to change. They are thinking about their own corporate governance and the need to invest some of their money in risk capital.”

Creating Culture

The government is seeking to support a move to a more entrepreneurial culture. Part of its approach has involved creating a national institute for entrepreneurship, known as the Instituto Nacional del Emprendedor (INADEM). INADEM’s aim is defined as increasing the productivity and competitiveness of Mexican companies by supporting innovation in the business community; it also seeks to “democratise innovation”. With educational and other partners, INADEM runs several training programmes. In early 2015 INADEM called for a range of different project proposals covering criteria such as technology transfer, business prototype development and specialised workshops (known as tech-shops or fab labs). When evaluating the proposals, it seeks to prioritise what it describes as double-impact innovation projects, with both a commercial objective but also a social, environmental, or cultural benefit. The institute also offers direct support to qualifying start-ups, prioritising those using IT, those in e-commerce, those in the creative and cultural sector, and those that can demonstrate a positive and measurable social or environmental impact.

In 2013, 683 projects were submitted to INADEM for consideration and 88 were supported. In 2014, 689 proposals were submitted and 153 were supported, almost double the previous year. INADEM also said it has been coaxing incubators to take a more practical and less theoretical approach. One way this is being achieved is by requiring them to move beyond the production of business plans to more detailed proposals, using descriptive techniques such as the business model canvas. INADEM provides validation and financial support for incubators, and now says that only those that can demonstrate they have successfully launched start-ups, and produce documented evidence of their survival and sustainability rates, will be recognised.

The institute has also been seeking to encourage the development of venture capital funds by offering to co-invest with them. Before 2013 there were only 15 Mexican venture capital funds investing in start-ups. In that year, however, INADEM’s co-investment scheme attracted 18 new funds, with a further 12 following in 2014. Under this scheme INADEM contributes up to MXN50m ($3.4m) to each venture fund, with the requirement that its contribution cannot exceed 49% of the total value of the fund. It calculates that in the two years to 2014 it invested MXN1.31bn ($88.2m) in venture funds, which took the total available for investment in start-ups to MXN2.35bn ($158.2m). These venture capital funds helped an estimated 300 new firms.

Enrique Jacob Rocha, president of INADEM, told OBG this form of co-investment with venture funds, “allows INADEM to become an institutional partner, sharing risk with private sector investors and encouraging them to invest more in early-stage innovation companies.”