The Smart Way to Make Profits While Serving the Poor
by Erik Simanis, Managing Director of Market Creation Strategies (7/16/12)
Most companies trying to do business with the 4 billion people who make up the world's poor follow a formula long touted by bottom-of-the-pyramid experts, however this model has a significant fatal flaw.
Most companies trying to do business with the 4 billion people who make up the world's poor follow a formula long touted by bottom-of-the-pyramid experts: Offer products at extremely low prices and margins, and hope to generate decent profits by selling enormous quantities of them. This "low price, low margin, high volume" model has held sway for more than a decade, largely on the basis of Hindustan Unilever's success in selling Wheel brand detergent to low-income consumers in India.
However, as I discussed in my last post, the model has a fatal flaw: It inevitably requires an impractical penetration rate of the target market — often 30% or more of all consumers in an area.
Any business that starts off needing a 30% or higher penetration rate is built on a shaky foundation. At the bottom of the pyramid, it's a losing proposition. Instead, companies seeking to improve the lives of the world's poor should focus on a more realistic route to profitability: They need to elevate gross margins far above the company average by pushing down variable costs and boosting the price consumers are willing to pay for a unit of product. They also need to drive up the price point for a single transaction. This combination of higher margins and higher price points boosts the contribution — the amount of money that goes to covering fixed and operating costs — generated from every transaction.
Generating a high contribution from every sales transaction requires a three-pronged margin-boosting approach: localized base products sold as a bundle, an enabling service, and customer peer groups.
Localize and bundle base products. A localized base product is an offering whose final processing prior to sale — such as dilution or combination with other components or ingredients — is done as close to the target market as possible. The company saves on labor costs because local wage rates are low. Solae, a global manufacturer of soy protein, was able to double gross margins by getting repeat customers to use their own refillable containers when they bought bulk protein.
Bundles save consumers time and money in gaining access to needed products and create a richer consumer experience whose total value is greater than the sum of the parts. At the same time, bundles allow companies to sell more per transaction. For instance, a low-income consumer can more easily lay out the money for a "body care kit" that contains several needed products such as shampoo, toothpaste, and other products than pay the same amount for a single product, like a large-size shampoo.
Makers of solar-powered lights — for example, D.Light and Duron — provide both light and other needed functionality, such as a capacity for recharging cell phones, in their products. Cosmos Ignite's MightyLight integrates a portable radio, and the company is considering adding more functionality, such as the ability to run battery-operated devices and water purifiers.
Offer an enabling service. To sustain high margins, it is also necessary to offer a service that engages customers and gives them the knowledge and skills needed to maximize products' functionality. A close relationship between consumers and service providers also adds intangible value to the consumer experience, allowing companies to charge a premium.
For example, for about $14 a week, Mexico-based cement manufacturer CEMEX sells low-income families a service that helps them build their own homes more effectively and at lower cost by providing access to inspections, warehousing of materials, and the advice of an architect. The price includes the company's cement products.
Cultivate customer peer groups. Like a sewing circle or an investment club, a customer peer group is a close-knit association of people who share an identity — but in this case, it's built around a product. Such groups extend the high-touch benefits of an enabling service, as members help one another adopt new behaviors and mind-sets that make the product more beneficial.
Peer groups also drive up the size of sales transactions: A single sale aggregates the demand of many customers. Grameen Bank, the microfinance bank in Bangladesh, is well known for its use of peer groups: Self-formed clubs of five to 10 people, usually women, share responsibility for microloans. A group will typically give itself a name and meet regularly to check on members' businesses. Grameen boosts the loan amounts given out per transaction by interacting with the lending circle, not individual borrowers. It attributes its 99% repayment rate in large part to the self-imposed discipline and mutual learning induced by the peer-group approach.
If companies wish to launch flourishing ventures capable of transforming the lives of millions of low-income people across the developing world, they must get back to basic business tenets. However laudable its mission, a business built on unrealistic expectations will fail just as surely at the bottom of the pyramid as in a developed market.
Because the high costs of doing business among the very poor demand a high contribution per transaction, companies must embrace the reality that high margins and price points aren't just a top-of-the-pyramid phenomenon; they're also a necessity for ensuring sustainable businesses at the bottom of the pyramid.
This blog post was excerpted from Erik Simanis' article "Reality Check at the Bottom of the Pyramid" in the June issue of Harvard Business Review and originally published by the Harvard Business Review.