Digital transformation beckons – but SMEs struggle to implement it

Digitalization can help SMEs expand beyond their traditional markets and partner networks, while reducing costs across business functions such as communications, administration, and marketing.

Yet, digital uptake by SMEs remains a challenge. Smaller firms often lack the skills, awareness, or internal capacity to identify the best solutions for their business, or to operationalize the changes their digital transformation would require.

SMEs usually start their digital journey with simpler technologies such as social media or basic web page creation. The gap between their capabilities and those of large firms widens as technologies become more sophisticated, or when a certain minimum scale is needed to amortize the costs of the transformation.

SMEs lag broadly in adoption of digital technologies. The complexity they struggle with results from the different trajectories their transformation can take, due to the different technologies that are available and different applications they support, as well as the different types of business SMEs operate. One solution cannot fit all.

Post-pandemic
COVID-19 accelerated the transformation of SMEs, prompting smaller businesses to move their operations online as lockdowns kept employees home and consumers away. It is estimated that up to 70% of all SMEs increased their use of digital tools during 2020, and that 60% to 80% of those viewed the changes as permanent. SMEs that were already digitalized before the pandemic could transition even faster, with less disruption.

But the change has remained limited to certain forms of digitalization, suggesting a forced adaptation rather than a strategic transformation.

The revolution may already be underway, however. Although adoption rates in most technological areas are slow to take off, recent business surveys point toward a massive migration to the cloud in 2020-21, with the share of small firms purchasing cloud computing services increasing faster than that of medium-sized and large firms. The cloud is a pivotal technology in SMEs’ digital journey, as it offers the opportunity to raise digital capacity without incurring investment costs upfront. It also enables technological leapfrogging, for example, towards data analytics and software-as-a-service.

Coping with mounting risks
SME migration to the digital world is not without risk. COVID-19 revealed SME’s vulnerabilities to cyber risks in particular. Ill-prepared but increasingly connected, SMEs become entry points to supply chains where hackers could reach larger and more profitable targets. SMEs need to acquire basic digital security hygiene and good risk management practices to be able to identify and contain data breaches rapidly.

Risks also come from distortions in competition due to the growing power of digital platforms. During the pandemic, these platforms became instrumental in connecting SMEs to their clients and partners. More broadly, they have enabled economies of scale (reducing production costs per unit) through the network effects they generate. As their user networks increase, digital platforms gain in profitability and business intelligence. They turn into gatekeepers to the markets they support by raising entry barriers, such as fees, by gaining unique market knowledge with the data they collect, and by placing their own products and services front and center in a way that chokes off competition.

Finally, digitalization carries risks of further exclusion for laggards. In the digital transition, benefits accrue to early adopters. SMEs’ capacity to access, protect, and turn data into business is critical for future business prospects.

SMEs matter
The digital transformation of SMEs is not only an economic challenge for individual actors. It has huge implications in places where SMEs are the main (or the only) local employer and taxpayer. And for network security broadly speaking, it will be imperative to make sure SMEs’ digital systems are secured.

The uptake of digital technology is also closely intertwined with the green transition. Greater sustainability, resource efficiency, and reduction of waste and emissions cannot be achieved without leveraging the potential of data and digital.

If one solution cannot fit all, we can still all learn from each other. To promote SME digital uptake and peer learning, the OECD has developed the Global Digital for SME Initiative, or D4SME. This platform aims to bring together OECD governments, large businesses, industry experts, and SMEs themselves to work on the many challenges at hand, and together promote the digital transformation of SMEs.

More OECD work on digitalization can be found here: https://www.oecd.org/digital/sme/