Human Resource Management Challenges in Sri Lankan Small and Medium Enterprises

Introduction

The small and medium-sized enterprises (SMEs) in Sri Lanka are varied, covering sectors like agriculture, manufacturing, services, and information technology. These businesses are essential for the country's economic diversity and growth.

 According to the Friedrich Naumann Foundation for Freedom (2025), SMEs comprise over 75% of all businesses in Sri Lanka. They provide 45% of jobs and contribute 52% to the gross domestic product (GDP). In the 2013/14 fiscal year, SMEs accounted for 98.5% of all industrial businesses, employing 45.7% of the total workforce in that sector. However, like many other developing countries, many SMEs in Sri Lanka operate informally.

 

Labor Law and HR Practices in Sri Lanka

 Labor laws serve as the backbone of effective human resources (HR) practices, ensuring that employee rights are safeguarded. Guided by the frameworks laid out by each country's labor department and the International Labor Organization (ILO), these regulations provide essential protections for workers. Adhering to such rules is not merely a legal obligation; it is a fundamental aspect of successful HR management. In today's dynamic business environment, organizations are increasingly recognizing the value of robust HR practices, as these strategies are pivotal in fostering a more engaged and productive workforce.

 In developing nations, small and medium-sized enterprises (SMEs) hold significant sway over the economy, contributing substantially to the gross domestic product (GDP). This places a vital responsibility on both the government and the organizations themselves to invest in and care for their employees, ultimately nurturing broader economic growth and social development.

 Some small and medium-sized enterprises (SMEs) focus on the well-being of their employees. With fewer employees, employers can better understand their staff and track their progress. In many small businesses, employers and employees work together like friends, which helps create a positive workplace. This friendly environment supports organizational growth because it encourages honesty and trust among everyone in the company. When employees feel valued, it leads to a stronger and more productive team.

 On the other hand, another part of SMEs in Sri Lanka operates primarily by fulfilling the basic mandates of labor laws. Yet, many employers fail to adopt modern HR functions that could elevate their workplaces. They often overlook the importance of systematically evaluating their employees' HR needs.

 One of the primary obstacles to addressing these HR needs is the economic instability that plagues many employers. Taxes and stringent government regulations impose burdens that can stifle growth and innovation. The ongoing financial crises have severely impacted organizational development, with the repercussions magnified by the challenges posed during the COVID-19 pandemic (Weerarathna, R.S., Rathnayake, R.M.N.M., Perera, L.R.H.G., Kaluarachchi, K.R.M., Arambawatta, L.V. and Weligodapola, H.W.M.C., (2022)). These factors create an environment where the development of effective HR practices often takes a back seat, limiting the potential for both employee satisfaction and organizational advancement.

Challenges

Figure: 01

Resource: Zainudeen, A., 2020

• Financial Instability

According to Zainudeen (2020), a lack of financing is a major issue that many small and medium-sized enterprises (SMEs) face, affecting around 59% of them. This situation creates significant challenges for employers, as high loan interest rates and rising production costs reduce the allocation for staff welfare and organizational development. Consequently, if they wish to implement a positive work culture within their organizations, financial issues often act as a barrier.

•  Lack of HR skilled Professionals

As industry costs continue to rise, employee turnover has become a significant challenge for employers. Consequently, many companies hire individuals with minimal qualifications, as highly skilled and talented professionals often come with a high price tag. The HR department faces similar challenges, making maintaining a strong HR function within an organization difficult. Critical areas such as skills development, employee analysis, and performance evaluation may suffer. If the HR department is not robust enough, issues such as salary management, employee evaluation, skills development and training, and handling employee turnover can become problematic (Recruitment Robin, (2025)). 

• Poor work-life balance

Many small and medium-sized enterprises (SMEs) are facing financial instability in the country. As a result, many private organizations are trying to operate with fewer staff members. Employees expect good salaries and are often required to work extra hours. This situation causes employees to feel tired, bored and stressed because they are doing the same job for long hours. Ultimately, this leads to lower efficiency. Unfortunately, organizations do not have effective solutions to address the issues for both employees and their operational needs.

•  Limited Career Growth Opportunities

In many small and medium-sized enterprises (SMEs), there are often limited opportunities for career advancement due to the organization's smaller size and fewer job openings in Sri Lanka. This can result in employee dissatisfaction and higher turnover rates, especially those seeking career development and growth.

Solutions

There are more solutions that can be proposed based on long-term and short-term strategies. A few we can consider are as follows:

• Performance based pay

Performance-based pay is designed to increase motivation. Employees are more motivated to achieve their goals when they know their efforts will be rewarded. The productivity of small and medium-sized enterprises (SMEs) depends on their employees' capabilities and innovations. Management can reward and appreciate employees, which will typically lead to higher performance levels (Recruitment Robin, (n.d.)).

On the other hand, performance-based pay also contributes to increased employee satisfaction. When employees are rewarded for their efforts, they feel valued and are generally more satisfied with their work.

• Structure-driven, data-enriched HR delivery system

A key deliverable for Human Resources (HR) is a fair and consistent performance and salary revision process. Small and medium enterprises (SMEs) should start by standardizing job roles, ensuring salary consistency within job levels, and defining clear Key Result Areas (KRAs) for all positions (Carriage, T. (2025)).

 This will help identify performance inconsistencies, salary gaps among peers, and non-standard designations. SMEs should then involve managers in performance and salary reviews, promoting fair treatment of employees. When managers take accountability, employees respond positively to the management approach.

• KPI Evaluations

Key Performance Indicators (KPIs) in Human Resource Management (HRM) are crucial for Small and Medium Enterprises (SMEs) to assess the effectiveness of their HR practices.

 One important KPI is the Employee Retention Rate. It shows how many employees stay with the company over time, helping to identify issues related to job satisfaction or workplace culture. Another key KPI is Time to hire, which measures how quickly the company fills open positions.

 Training and Development Hours indicate how much the company invests in employee growth and skill improvement, which can boost productivity. Employee Satisfaction and Engagement surveys give insights into how motivated and committed employees are, impacting overall performance.

 The Performance Appraisal Completion Rate shows if employees receive regular feedback and development opportunities that support their growth. The Internal Promotion Rate reflects how well the company promotes talent from within, helping to reduce turnover and improve morale (Yadavalli, Srinivasa & Reddy, T & Babu, Neerugatti. (2024)).

 Finally, the Employee Turnover Rate measures the percentage of employees who leave the company. This provides insights into how well the company retains its staff. These KPIs are crucial for SMEs to enhance their HR practices, use resources wisely, and align HR strategies with business goals.

Conclusion

Small and medium-sized enterprises (SMEs) in Sri Lanka play a crucial role in the country’s economic growth, making significant contributions to employment and the country's GDP. By investing in employee development and standardizing human resource processes, SMEs can cultivate a more engaged and motivated workforce. Overcoming economic challenges and promoting a positive workplace culture can also lead to long-term success. When SMEs address these HR issues, it encourages organizational growth and contributes to broader economic development in the country. Ultimately, prioritizing strategic HR management will enable SMEs to thrive in a competitive business environment.

 

References

Friedrich Naumann Foundation for Freedom, 2025. SMEs in Sri Lanka: Small and Medium-sized Enterprises (SMEs) of Sri Lanka. Available at: https://www.freiheit.org/south-asia/small-and-medium-sized-enterprises-smes-sri-lanka [Accessed 23 Mar. 2025].

Weerarathna, R.S., Rathnayake, R.M.N.M., Perera, L.R.H.G., Kaluarachchi, K.R.M., Arambawatta, L.V. and Weligodapola, H.W.M.C., 2022. The changing face of HR professionals’ expectations amidst COVID-19: a comparison in between Sri Lanka and foreign context. Quality & Quantity, 56(6), pp.4307-4326. Available at: https://doi.org/10.1007/s11135-022-01533-3 [Accessed 23 Mar. 2025].

Zainudeen, A., 2020. Unlocking the Potential of Micro, Small and Medium Enterprises Essential to Sri Lanka’s Post-COVID Economic Recovery (Part 2). Advocata Institute. Available at: https://www.advocata.org/commentary-archives/tag/small+and+medium+enterprises [Accessed 23 Mar. 2025].

Carriage, T., 2025. HR challenges in SMEs: Basic reasons and solutions. [online] LinkedIn. Available at: https://www.linkedin.com/pulse/hr-challenges-smes-basic-reasons-solutions-talent-carriage/ [Accessed 24 March 2025].

Recruitment Robin, 2025. Are you feeling the effects of the HR skills shortage? Here’s how our HR support services can help. [online] Available at: https://recruitmentrobin.com/are-you-feeling-the-effects-of-the-hr-skills-shortage-heres-how-our-hr-support-services-can-help/#:~:text=A%20lack%20of%20dedicated%20HR,rates%2C%20further%20exacerbating%20the%20problem [Accessed 24 March 2025].

Recruitment Robin, n.d. Are you feeling the effects of the HR skills shortage? Here’s how our HR support services can help. [online] Available at: https://recruitmentrobin.com/are-you-feeling-the-effects-of-the-hr-skills-shortage-heres-how-our-hr-support-services-can-help/#:~:text=A%20lack%20of%20dedicated%20HR,rates%2C%20further%20exacerbating%20the%20problem [Accessed 24 March 2025].

Yadavalli, Srinivasa & Reddy, T & Babu, Neerugatti. (2024). Small and Medium Sized Enterprises Key Performance Indicators. 11. 01-06. 10.9790/5933-1104060106.