In 2007, a Mexican pet store was on the brink of disaster. The owner had fallen behind on a loan and had taken out another loan to pay off the first. Now all of the store’s revenue was being thrown at a growing mound of debt—and its eight employees couldn’t be paid.
The story is not unique. Small to medium enterprises frequently have trouble expanding past a certain size, particularly in developing economies like Mexico.
“There are all sorts of theories about why that is,” says Dean Karlan, a professor of finance at the Kellogg School, “and one of them is about managerial capital.” That is, business owners might lack the unique set of skills and business savvy, such as managing people or creating a business plan, required to help their companies reach the next level.
Could tailored advice from an experienced consultant make up for gaps in managerial know-how? And would filling those gaps help companies overcome hurdles and keep growing?
In 2008, the state of Puebla’s Ministry of the Labor decided to offer highly subsidized consulting services. And critically, they wanted to learn whether such consulting actually worked. They reached out to Karlan and economists Miriam Bruhn of the World Bank and Antoinette Schoar of MIT, as well as Innovations for Poverty Action (a nonprofit organization founded by Karlan), to help evaluate the consultants’ efforts.
Eighty randomly selected firms ended up with consultants. The consultants conducted a daylong diagnostic session with each firm and then designed a consulting routine for the next year. Meanwhile, a control group of 282 companies continued operating as usual, without expert advice.
The average firm that had received consulting grew its staff by 57 percent.
A year later, the researchers found, the firms that were offered consultants saw both their productivity and their return on assets increase relative to the control group.
Then, using data from Mexico’s social security agency, the researchers tracked the companies for another five years—long after the consulting services had ended—to see what happened to payrolls.
They found that the average firm that had received consulting grew its staff by 57 percent over that period, while the average firm in the control group remained roughly the same size. Furthermore, total wages paid by firms that had had consultants increased 72 percent, indicating that they were increasing employees’ pay over that period as well. As for the struggling pet store, it saw profits increase a full 50 percent, despite starting on the brink of bankruptcy.
The results were remarkable. But the researchers could not help but wonder: What, exactly, had the consultants changed?
After the first year of the experiment, the researchers conducted a survey asking firm owners what had made their consultant so valuable. The answers varied widely: some said the consultants improved their marketing or accounting, while others pointed to different dimensions, like pricing or human resources.
The researchers also measured the owners’ “entrepreneurial spirit” and found that owners who had been randomly selected to receive subsidized consulting said they were more goal-oriented, more driven, and more confident in their problem-solving abilities than they had been before the consulting.
While this is an intriguing result, it is complicated to interpret, Karlan explains. It is possible that the consultants provided the firm owners with new skills and information, which they used to grow their companies, just as the Ministry of Labor had intended. And then that newfound growth gave them higher levels of entrepreneurial spirit. Alternatively, maybe the consultants imbued the owners with a newfound confidence, which empowered them to make the tough, risky decisions they knew would benefit the firm.
One of the main questions Karlan felt remained unanswered: If the consultants were so good at helping other businesses grow, why weren’t the consultants’ own businesses growing with leaps and bounds? This is an area Karlan is keen to pursue: Are there contracting challenges, trust problems, information problems, liquidity problems? What is holding back the market for these consultants?