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					                                 A grassroots approach to emerging-market consumers   61

A grassroots approach
to emerging-market
By tapping into local networks, companies can serve low-income markets
profitably, delivering significant value to shareholders while creating the
essential market infrastructure for economic development in the neediest

                             Christopher P. Beshouri

When companies figure out how to serve low-income consumers in
developing countries profitably, everyone wins: the disadvantaged gain
access to products and services that the private sector is best positioned to
deliver, while companies tap into vast new markets. On top of that,
when core sectors of the economy—such as banking, electricity, telecom-
munications, and water—thrive, they transform consumers into producers
and promote economic development.

Unfortunately, this happy dynamic is more the exception than the rule. Low-
income consumers just can’t afford many products and services. A shaky
infrastructure raises the costs of distribution. Incomplete information makes
extending credit difficult, and collecting what’s owed poses enormous
challenges. Some low-income consumers feel entitled to connect into water
mains or electricity lines illegally. Low-income environments are also more
susceptible to insurgent activities that raise security and infrastructure costs.

To complicate matters, the resolution of these issues sometimes calls for
untangling a unique principal-agent problem. A company (the principal) is
in a weaker position than the community (the agent) when it comes to
gaining local information, shaping people’s views, and dealing with bad
behavior—by defaulters, for example—that could disrupt service for
customers and company alike.
62       The McKinsey Quarterly 2006 Number 4

      Article at a glance
                                                           A few companies are adopting
     Companies serving low-income consumers in
                                                           creative community-based solutions
     developing countries face daunting problems, such     to overcome many of the diffi-
     as security, customer acquisition, distribution,      culties they face serving low-income
     and collection.
      What’s more, for obtaining information about local
      developments, shaping viewpoints, and sanction-      •   In the Philippines, Manila Water
      ing behavior, companies are frequently in a weaker
      position than communities.                               relies on collective billing to
                                                               ensure the timely payment of bills,
     The solution involves enlisting community leaders
     and residents to monitor and influence developments       employs small-scale entrepreneurs
     on the ground and to create a positive dynamic that       as couriers and pipeline con-
     helps companies adapt their business models to the        tractors, supports microlending,
     challenge of serving low-income consumers.
                                                               and brings affordable water
     Building awareness and providing economic benefits        to schools and hospitals. The
     that extend beyond core products and services
                                                               mobile-telephony providers Globe
     are often key elements of a community strategy.
                                                               Telecom and Smart Communica-
                                                               tions use initiatives (ranging from
      Related articles
      on                                 educational programs to food
     “What is the business of business?”                       and medical assistance) that
      2005 Number 3                                            benefit the whole community to
     “The McKinsey Global Survey of Business Executives:       encourage local leaders to
      Business and Society,”                                   safeguard cell towers and protect
      Web exclusive, January 2006                              company employees.
     “Corporations as global citizens,”
      2004 Number 1                              In Mexico, Cemex’s Patrimonio
                                                 Hoy program broadens access
                                                 to services and to cement and other
         building materials by organizing low-income customers into groups
         of three families that monitor each other’s progress in constructing their
         own homes and collectively pay off debts at regular ten-week inter-
         vals. To promote and monitor the program, Cemex employs people, such
         as teachers and church leaders, who have large personal networks and
         are widely trusted.

     •   In India, Hindustan Lever has developed Shakti, a program that trains
         rural women to operate as entrepreneurial distributors of consumer
         products in villages of fewer than 1,000 people. This effort generates
         annual sales of roughly $250 million in villages that would otherwise
         be uneconomic to serve.

      Some of the benefits are directly measurable. Manila Water serves 5.1 mil-
      lion residents, has trained more than 1,000 engineers, and disburses a
      $16 million annual payroll in impoverished east Manila. The distribution of
      mobile-telephony services in the Philippines generates roughly $200 million
                                                 A grassroots approach to emerging-market consumers              63

    a year for more than one million small-store proprietors. Cemex has made
    home ownership a reality for 70,000 low-income Mexican families.
    Hindustan Lever’s Shakti program provides annual cash flows of roughly
    $25 million to its female distributors. And the Grameen Bank of Bangladesh,
    which along with founder Muhammad Yunus won the 2006 Nobel Peace
    Prize, has made small loans to 6.6 million people while providing services
    in more than 70,000 villages.

    Less quantifiable benefits are just as important. Cheaper, higher-quality
    water frees up income for other purchases and raises the quality of life and
    health. Reliable telecom services help farmers ascertain market prices,
    make it less necessary to use bad roads, and provide a substitute for weak
    postal services. Home ownership raises the net worth of families, makes them
    more safe, and generates self-esteem. In addition, many of these programs
    promote a culture of entrepreneurship.

                                                      In view of the benefits, it might seem
 The idea that social issues can be
                                                      natural to describe community-
 central to strategy is applicable                    based initiatives as a form of corporate
 beyond low-income markets. For a
 broader look at this topic, see
                                                      social responsibility. Yet in most
“When social issues become strategic,”                cases, the local initiatives actually make
                                                      the business sustainable. Addressing
                                                      social issues, in short, isn’t adjacent to
                                                      strategy but rather central to it.

    What are the obstacles?
    The higher costs of doing business and the fundamental principal-agent
    problems prevalent in low-income markets will take on growing import-
    ance in the future: at least ten of them are in fast-growing economies that
    together represent about half of the world’s population and nearly $15 tril-
    lion in income.1 Within such economies, the most important—and difficult—
    business sectors for solving the low-income challenge are those where the
    expected profit is low but the potential impact of successful penetration is
    high (Exhibit 1, on the next page). Water and mobile telephony are prime
    examples, and the Philippines is a prototypical low-income market: the
    bottom 90 percent of households, representing more than 60 percent of the
    country’s purchasing power, each earn an average of less than $300 a month.

    Familiar, but more daunting . . .
    Some of the factors that raise the cost of serving poor consumers
    are actually acute forms of challenges that businesses confront across all
    consumer segments.

    Brazil, China, India, Indonesia, Malaysia, Mexico, the Philippines, Russia, Thailand, and Turkey. GDPs are
    calculated on a purchasing-power-parity basis.
     Q4 2006
     Low income
     Exhibit 1 of 3
64    The McKinsey Quarterly 2006 where expected profit is low but potential
     Glance: Special attention is needed Number 4
     impact on economic development is high.

     Taking on the challenge

     Developmental impact and expected profitability of industries in low-income markets

                                                                                                                                         Typically governments,
                                                                     Electricity                 Credit
      Developmental impact on community’s economy

                                                                                                                                         multilaterals (eg, United
                                                                                                                                         Nations, World Bank), and
                                                                                                                                         nongovernmental organizations
                                                                                                                                         (NGOs) perceived as highly
                                                                                                                                         developmental but unprofitable



                                                                                                                                         Businesses stereotyped as highly
                                                                                                                                         profitable but with little or no
                                                                                                                                         contribution to development
                                                               Low                               Moderate                         High
                                                                           Expected profitability of serving low-income segment

     Customer acquisition and parceling. When low disposable incomes limit
     the amount consumers can buy at any one time, it becomes extremely
     important to deliver products and services in affordable parcels, such as
     single-use packets of products like shampoo or detergent. Consider the
     problem faced by Globe Telecom and Smart Communications, operating in
     a country where a mobile handset costing 3,000 pesos (roughly $60) might
     represent 20 percent of an average low-income consumer’s monthly wages.
     Acquiring new customers was virtually impossible without radical changes
     in the parceling and pricing of services.

     Collection. Consumers in low-income segments have trouble saving money,
     given their pressing need for liquidity. This factor makes the collection
     problem acute for sectors such as telecom services and water, where con-
     sumers generally receive bills after consumption. Furthermore, the
     difficulty (and sometimes the danger) of locating and contacting delinquent
     consumers raises costs. And the harder it is to collect, the higher the
     eligibility standards that companies must set for their customers; this in
     turn reinforces the problem of acquiring new ones.

     Infrastructure. Low-quality roads, postal services, electricity, and other
     basic forms of infrastructure make it harder and costlier to support
     production and distribution in many areas. A large number of households
                                A grassroots approach to emerging-market consumers   65

in Manila Water’s target market, for example, live in shanties that lack
proper faucets, toilets, or in-house piping. As a result, not only service
providers but also potential customers must start from scratch. For cus-
tomers, the cost of installing basic plumbing can be substantial—around
7,000 pesos, or more than 40 percent of the average monthly income.

. . . and unusual
 Other difficulties are less familiar to companies that primarily serve more
 affluent consumers.

Desperation. As a result of a 1997 privatization initiative, Manila Water
has the right to sell water in the eastern part of the metropolitan area.
Before then, all of it was served by a government monopoly, and roughly
65 percent of the water that left the treatment plant was “nonrevenue
water.” A weak infrastructure was responsible for a good deal of the problem,
but as much as one-third of it resulted from pilferage. Consumers felt
that they had to make illegal connections to the pipeline in order to obtain
water—something vital to the hygiene and health of their families. But
pilferage jeopardizes the long-run provision of services.

Security. Large concentrations of low-income consumers who endure high
unemployment and receive minimal government support are ripe targets
for radical political and social groups that encourage resistance to contracts
and threaten corporate assets. Since 2002, for instance, lawless elements
have damaged more than 30 of Globe Telecom’s cell sites in retaliation for
the company’s refusal to pay “revolutionary taxes.” Protecting infrastruc-
ture from straightforward theft is also a problem: copper cables belonging
to Globe Telecom and Smart Communications have been cut and sold
as scrap metal.

Education and culture. Companies must often invest to overcome or accom-
modate mind-sets that undermine consumer participation in conventional
market transactions. In the Philippines, for example, there is a ubiquitous
custom of “five-six” lending: borrowing five pesos and repaying six, usually
within a week, for an annual interest rate of roughly 13,000 percent. Since
low-income consumers, lacking good information and formal education,
don’t understand the implications of this kind of borrowing, they wind
up even poorer and further removed from the economic mainstream.

The solution lies in the community
Running through many of these challenges is a classic principal-agent
problem: a variety of agents (consumers and community leaders) may act in
ways that are not necessarily in the best interests of the principal (product
66    The McKinsey Quarterly 2006 Number 4

     and service providers). For the phone companies and Manila Water,
     the conventional solution would be to safeguard thousands of base stations
     and hundreds of miles of pipeline with security guards, police protection,
     and enclosures. Since tactics like these would be prohibitively expensive,
     companies need creative business models to resolve principal-agent
     problems in a sustainable way.

     People in local communities—not only the mayors and barangay (village)
     captains but also school principals, teachers, religious leaders, and residents
     themselves—are in the best position to help companies deal with the
     challenges of doing business in low-income areas. These community agents
     have the information and ability to monitor and influence what happens
     on the ground. If a company can show that its own interests are aligned with
     their interest in employment and commerce, it can then enlist community
     Q4 2006
     support for security, collection, and system monitoring. Community-based
     Low income
     approaches help companies address principal-agent issues head on while
     Exhibit 2 of 3
     Glance: One positive dynamic of commercial and community interactions.
     creating a can map the dynamics that reinforces key business model adaptations
     (Exhibit 2).

     Commercial and community dynamics

         Key intervention points

         Community events1

                                     support, stability
                                   • Community action                                   Enabling
                                   • Asset security                                     infrastructure
                                                                                      • Transport
                                                                                      • Fulfillment
                                                                                      • Payments services
                                                                                      • Interactive platform

       Productive capacity                                    Primary service
     • Human capital                   Community              provider2                     Business           Micromarket traffic
     • Health                                               • Products and services                            (economic activity in
     • Safety                                               • Costs (operating,                                local market)
                                                            • Business model

                                     Community wealth                                   Capital, labor
                                   • Initial condition                                  employment
                                   • Accumulated benefit                               • Key workers
                                                                                      • Suppliers
                                                                                      • Investments

     For example, disaster relief, distribution of food, medicine.
     For example, banking, electricity, telephony, water.
     For example, job-training campaigns, information, key workers.
                                 A grassroots approach to emerging-market consumers   67

To understand these dynamics, consider what happens when a telecom
company provides service in an area. Rising local employment at the
company and its suppliers stimulates local economic activity. Meanwhile,
telecom services make transportation, the flow of information, and the
fulfillment of transactions cheaper and easier. These second-order benefits
make the community better off, which of course stimulates demand and
improves the way the community perceives the company. Improved align-
ment between the community and the business, in turn, makes it easier to
address issues such as security and pilferage. Education and initiatives that
make communities more aware of the broader economic and social role that
companies play can reinforce the positive dynamics or reverse negative ones.

While tapping into these commercial and community dynamics, Manila
Water, Globe Telecom, and Smart Communications have delivered strong
returns on invested capital—around 19 percent, 16 percent, and 17 per-
cent, respectively, over the past three years. Let’s explore the stories behind
the numbers at Manila Water and Globe Telecom.

How Manila Water does it
To overcome the difficulties in acquisition and collection, Manila Water
devised a game-changing scheme: letting communities themselves decide
if they want individual or collective installation, metering, and billing. The
company offers three options: one meter per household, one meter for
3 or 4 households, and a bulk meter for 40 to 50 households. Where house-
holds band together, the connection fee (ordinarily 7,000 pesos a household)
can fall by as much as 60 percent, depending on the number of customers
who shoulder the cost of pipes, the meter, and installation. Submeters
measure water usage in each household, and everyone on a group meter
takes responsibility for paying the total bill, an arrangement that in effect
gives consumers (and Manila Water) group insurance coverage on payment.

About 30 percent of the urban poor served by Manila Water now pool their
bills, and in communities using this technique the company collects 100 per-
cent of the money they owe. Consumers recognize both the savings from
collective installation and the fact that ensuring sustained service depends
upon their own actions. Tied households, given their close proximity, can
observe and shape day-to-day behavior, encourage the cluster’s members to
meet their obligations, and impose sanctions on those who don’t.

Nonetheless, some low-income consumers still make illegal connections
to the company’s pipelines. Furthermore, winning cooperation from
local officials—absolutely essential for a heavily regulated business—is
problematic for a company like Manila Water, which eschews the bribes
and other extralegal practices many businesses accept. The company’s
68       The McKinsey Quarterly 2006 Number 4

     response has been to come up with several community-based initiatives.
     They include the following:

     •   Providing jobs to more than 10,000 people, either as couriers who deliver
         Manila Water’s bills or as contractors who help lay pipelines; the
         company also fosters the development of small supplier businesses and
         cooperatives, such as printing outfits.

     •   Bringing clean, affordable water to public schools, hospitals, and
         markets—institutions of great importance to the broader community—
         while addressing the sanitation needs of low-income residents.

     •   Increasing awareness within the community that illegal connections
         pose a risk to the long-run provision of water and that canned water is
         seven times more expensive than the company’s offering.

     •   Making small loans, in partnership with Bank of the Philippine Islands
         and the International Finance Corporation, to organized groups operating
         microenterprises such as street stalls and food services.

     Combined with collective billing, these actions are solving the principal-
     agent problem by giving agent communities a vested interest in prin-
     cipal Manila Water’s viability. As people see their living conditions and
     productivity improve, they become more willing to monitor water
     connections, protect infrastructure, ensure timely payment, and win over
     local-government officials.

     Globe’s approach
     Globe Telecom began expanding into lower-income segments in 1998
     because the top of the market was too small to support the capital expen-
     ditures required to extend the company’s mobile network throughout
     the Philippines. Its initial push involved selling prepaid service cards in
     denominations of 300 and 500 pesos. Although the prepaid scheme
     eliminated most of the problems associated with billing, assessing credit
     risks, and collection while significantly expanding the market, the cards
     were vulnerable to theft. Furthermore, manufacturing and distribution costs
     made it uneconomic to offer cards worth less than 300 pesos, and at
     around $6 these were pricey for many consumers.

     Globe responded by delivering small-value bundles through over-the-air
     (OTA) reloading: customers pay a licensed distributor for network access.
     Since the costs associated with OTA are almost zero, it can involve whatever
     amount of money the customer wants, down to a single peso. The cus-
     tomer takes a mobile phone to a sari-sari store (small roadside variety shops
                                 A grassroots approach to emerging-market consumers   69

preferred by 90 percent of Philippine consumers) or a village store, gives the
proprietor the money, and the proprietor uses a mobile phone to transfer
a load onto the customer’s phone. The customer can then make calls until
the credit is used up. OTA to wholesalers has eliminated the opportunity
for card heists while allowing Globe—and Smart, which also employs OTA—
to relax the eligibility requirements for wholesalers. (After all, the com-
panies can swiftly identify and take action against slow-paying ones.) Both
credit risk and the initial cost of setting up shop decline. As a result, the
benefits are being felt by an army of proprietors; their numbers have swelled
from 50,000 in 2003 to more than 400,000 in 2006 for Globe alone (and
to more than 1,000,000 in the industry as a whole).

Providing a livelihood for shopkeepers is just one of the many ways Globe
is deepening its ties with low-income communities where the company
has assets, such as base stations, offices, and business centers. There are
others as well:

•   Providing aid (including food, medical missions, books, and educational
    TVs) for primary schools, as well as an engineering curriculum for
    vocational schools; Globe tailors programs to local needs by consulting
    community leaders, who frequently, in turn, become supporters of the
    company’s broader activities.

•   Building awareness of the way mobile services help people and communi-
    ties to flourish, such as giving farmers updates on weather conditions
    and rapid, low-cost access to market prices.

•   Using mobile handsets as an electronic payment mechanism to deliver
    credit safely and cost effectively. The phone sends payments from one
    individual or business to another (much as some consumers use PayPal for
    Internet transactions), so the lender can see how the person receiving
    the money actually spends it, in real time.

As the link between Globe Telecom and employment-income, education,
and medicine becomes more explicit in people’s minds, low-income
communities help the company both to protect its assets and employees
and to deepen its subscriber penetration.

Exportable lessons
Some clear lessons emerge from the experiences of Manila Water and Globe
Telecom, as well as other budding leaders, such as Cemex, Hindustan
Lever, and Smart Communications. Communities are frequently in a better
position than companies are to resolve issues that make it uneconomic to
serve low-income groups. Building awareness of the benefits that a company
70    The McKinsey Quarterly 2006 Number 4

     can bring is essential for resolving principal-agent problems. And companies
     that want to solidify their role in low-income communities must typically
     provide economic benefits beyond the direct impact of their core products
     and services.

     Another way companies can make a
                                           Within these broad guidelines, three
     difference in low-income communities  business model archetypes are
     is through long-term, systematic phil-
                                           emerging (Exhibit 3). Each addresses
     anthropic efforts. See “One business’s
     commitment to society: An interview   different aspects of the low-income
     with the president of the Novartis    challenge and can be used individu-
     Foundation for Sustainable Develop-
     ment,” on      ally or in combination. The first—
                                          “collective accountability”—focuses on
                                           collection problems associated with
     either direct lending or postpaid services. This approach involves developing
     small groups, such as Cemex’s family clusters or Manila Water’s collective-
     billing units, whose members substitute for the monitoring efforts of the
     business itself and provide “social insurance” to one another.

     The second business model—“scalable, embedded distribution”—reduces
     costs and promotes a company’s reputation by enlisting trusted community
     members (such as the sari-sari proprietors, Cemex’s Patrimonio Hoy
     Q4 2006
     monitors, and Hindustan Lever’s entrepreneurial women) to provide the
     Low income
     distribution infrastructure for goods and services. The challenge, of
     Exhibit of 3
     course,3is how to recruit, train, and manage an army of community-based
             Hindustan Lever, whose Shakti the low-income expanded
     agents.Three models address different aspects of program has challenge. from

     Three models are emerging

     Business         Core issue                  Community-based                   Relevant               Sample
     model            addressed                   intervention                      industries             businesses

     Collective       Problems with collection,   Small groups monitor          • Utilities, eg,       •   Manila Water
     accountability   pilferage                   usage, promote compliance,      water, electricity       (Philippines)
                                                  provide social insurance      • Finance              •   ICICI Bank

     Scalable,        Traditional delivery too    Low-cost, community-          • Fast-moving          • Indofood
     embedded         costly relative to          based distribution              consumer goods         (Indonesia)
     distribution     purchase size, density      points employ key workers     • Telecom              • Hindustan Lever
                      of consumers                in low-income areas           • Low-value consumer     (India)
                                                                                  goods                • Kodak Brazil

     Livelihood       Brands lack positive        Business offers additional    • Telephony services   • Globe Telecom
     partnership      equity; cultural            services around core          • Utilities, eg,         (Philippines)
                      divisions can separate      product/service that            water, electricity   • Manila Water
                      interests of consumers      promote primary demand        • Agriculture            (Philippines)
                      and producers               while providing training or                          • ITC e-Choupal
                                                  cooperative business                                   (India)
                                                  programs to community
                                    A grassroots approach to emerging-market consumers    71

50 villages with 150 rural women in 2001 to 80,000 villages with 25,000
women entrepreneurs today, has created a four-week training program for
all participants and employs some of the company’s leading entrepreneurs
as trainers.

Companies that use the third of these business model archetypes—“livelihood
partnerships”—surround a core product or service with additional bene-
fits. Rather than treating communities purely as collections of consumers,
companies that take this approach provide low-cost, productivity-
enhancing assistance, such as Manila Water’s training and cooperative
business programs. These initiatives bridge cultural gaps between
company and community, create positive associations with the company’s
brand, raise switching costs, and promote micromarket activity. All
this has positive consequences for both the community and the companies
doing business there.

All three approaches involve deep, long-term community relationships and
investments, whose value is illustrated by the extraordinary support
Manila Water received when it asked regulators for a rate increase in 2002.
Ninety barangay captains and community leaders showed up at the hear-
ing and expressed their appreciation for the powerful positive impact Manila
Water had on their communities. These people told stories about the way
residents formerly began their trek at midnight to get water back to their
households by dawn, about new jobs and entrepreneurial activity, and
about Manila Water’s support for the community’s special needs and projects.
To these local leaders, Manila Water had become an essential partner
in their livelihood and quality of life; they were prepared to stand by
the company.

Serving the bottom of the income pyramid may seem daunting. But by
crafting community-based strategies that reflect the distinct characteristics of
the low-income segment, companies can tap into a huge growth opportunity
for themselves and achieve competitive rates of return while also delivering
important developmental benefits to the communities they serve.           Q
  The author would like to thank Kristine Romano, Adam Schwarz, and Benjamin Soemartopo
                              for their contributions to this article.
         Christopher Beshouri is an associate principal in McKinsey’s Manila office.
                           Copyright © 2006 McKinsey & Company.
                                        All rights reserved.

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