An evaluation of the merits of targeting customers at the bottom of the pyramid.

In what sectors and in which ways, if any, do the considerations raised by this approach alter the strategies of multinational corporations selling into emerging markets?

Maja Regg ruegg3@hei.unige.ch

Prof. Simon J. Evenett International Business

Graduate Institute of International Studies, Geneva

May 2007

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International Business Second Assignment

The income pyramid in emerging markets can be divided in four segments: From top down, it contains the global, the glocal, the local segments and the bottom of the pyramid (BOP). According to an approach first introduced by C.K. Prahalad, the BOP is an untapped market. He maintains that multinational corporations (MNCs) which sell to the poor will not only gain huge profits, but also alleviate poverty.1 In this paper, I will evaluate the merits of the BOP approach from a business perspective by focusing on the strategic implications for a MNC willing to sell to the BOP. Taking the example of India, I will first define the market at the BOP in terms of size and characteristics. Then, I will discuss three dimensions in which the BOP approach alters the corporate strategies of MNCs, namely the collaboration with nontraditional partners, the efforts for custom solutions and the creation of a local base of support. After each dimension, I will evaluate the success of such a strategy for MNCs active in the sectors of basic sanitary products and prostheses. Finally, I will compare the prospect of profits for MNCs with those of local firms.

Prahalad is not very consistent when defining the upper limit of the BOP. Yet the mostly used figure is a dividing rule of 1500$ income per year. In the case of India, however, this definition is inadequate, as it would include 94% of the whole population.2 Instead, I propose to adopt Aneel Karnanis delimitation line of 2$ income per day.3 Measured this way, the bottom of the pyramid contains 87.5% of the rural and 61.5% of the urban population, or roughly three quarters of the total population.4 This definition has the two following implications. Firstly, in terms of market size, the BOP in India is still very large, containing 750 million people. Secondly, in terms of purchasing power, the market is very limited due to the small disposable income of the customers. Therefore, the fortune at the BOP might be smaller than suggested by Prahalad and his associates.

A delimitation line of 2$ per day has further implications on the pattern of consumption that people at the BOP present. About a quarter of them earn less than 1$ per day, living in extreme poverty. According to Karnani and Sachs, they cannot meet the basic needs for survival such as nutrition, health care, safe drinking water, sanitation, education for children, adequate shelter and clothing. The remaining moderate poor, earning 1$-2$ per day, can

Prahalad C.K. and Hart S., The Fortune at the Bottom of the Pyramid, 2002; Prahalad C.K. and Hammond A., Serving the Worlds Poor, Profitably, 2002; Hammond A. and Prahalad C.K., Selling to the Poor, 2004. 2 World Bank figures from 2004, Povcal Net http://iresearch.worldbank.org/PovcalNet/jsp/index.jsp 3 Karnani A., Mirage at the bottom of the pyramid, August 2006 4 World Bank, op. cit.

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meet their basic needs, but just barely.5 According to the Indian government, poor people spend 60-65% of their income solely on food. On miscellaneous services between 15-19% of the income are spent.6 This means that on products from such sectors as health, entertainment and communications, people at the BOP can spend between 0 and 0.38$ per day. I agree with Karnani that such a small disposable income does not allow these people to buy luxury products. In India, the consumers at the BOP are likely to buy only very cheap and much needed products.

This conclusion is in tension with Prahalads opinion. He maintains that every product even luxury ones can be sold in large quantities as long as the MNCs adapt their strategies to the BOP market. The advices he gives concerning these altered strategies will be introduced in the following. Based on a framework elaborated by London and Hart7, I will classify these strategic advices in three dimensions: The collaboration with non-traditional partners, the elaboration of a custom solution and the creation of a local base of support. I will test each of these dimensions of corporate strategy with two MNCs belonging to different sectors and willing to sell their products to the Indian BOP. The first sector concerns basic sanitary products. Specifically, I will refer to a MNC selling soaps, such as the example of Hindustan Lever Ltd.8, often cited by Prahalad. The second sectors concerns prostheses. The corporate example used by Prahalad is a local firm called Jaipur Foot9. I will refer to a MNC disposed to start a comparable venture selling lower limb prostheses to the poor.

The first strategic dimension refers to the collaboration with non-traditional partners, which should be part of the non-market strategy of the MNCs. According to Prahalad, in order for a MNC to be successful, its venture must not adopt a Western corporate strategy. It has to get the deepest possible insight in the business environment at the BOP. This is done best by collaborating with non-traditional partners such as NGOs and local firms, which know the characteristics of the BOP very well.10 Nevertheless, especially organisations with a strong social mission are likely to be sceptical to deal with MNCs. Therefore, the MNCs will have to show the social value of their ventures. Furthermore, MNCs might have to get used to very different working styles of their new partners.

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Karnani A., op. cit.; Sachs D., The end of poverty, March 2005 Karnani A., op. cit. 7 London T. and Hart S., Reinventing strategies for emerging markets: beyond the transnational model, 2004 8 Michigan Business School, student case study: Selling Health: Hindustan Lever Ltd. and the Soap Market 9 Michigan Business School, student case study: Jaipur Foot: Challenging Convention 10 London T. and Hart S., op. cit.

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Both the MNC selling soaps as well as the one selling prostheses could undertake various efforts to establish such partnerships. In order to get used to different working styles, they could send some of their executives to live several months in Indias rural areas. Furthermore, the MNCs could win the goodwill of the organisations by launching campaigns emphasizing their products added-value in terms of improvement of hygiene and living conditions. One has to keep in mind, though, that the efforts made in this first strategic dimension imply significant costs for the MNCs.

The second dimension of advices tackles the process of co-inventing custom solutions. These advices concern the market strategy and advance two aspects, which MNCs have to consider: The price of the product and the business model. As we have seen above, due to the extremely low income of Indians at the BOP, a very low price is essential. MNCs normally use economies of scale to reduce their production costs and consequently their selling price. As an additional way to lower the price, Prahalad further suggests to sell products as cheap single serves. Karnani, on the contrary, maintains that the only way to reduce costs is by reducing quality. 11 What are the implications for the two MNCs considered here? For the MNC selling soap, the strategy advices work out: As the product is very basic, it can be sold across several regions without much customisation. Therefore, the MNC can use economies of scale to produce cheap soaps. They can also offer single serves of soap and sell them very cheaply. Finally, even if they have to reduce quality in order to keep the price very low, the people at the BOP will still consume the product in large quantities. The situation for the MNC selling prostheses is very different: It can only rely on economies of scale to a very low degree as its product has to be highly customised. Furthermore, there is no such thing as a single serve of prosthesis. And finally, the product is something poor people will have to save for during a long time period.12 Therefore, they will have higher expectancies concerning the quality of the prostheses.13 For all these reasons, I conclude that the first aspect of a custom solution, the low price, is easier to obtain in the case of soaps than in the case of prostheses.

Karnani, op. cit. As a reference, Jaipur Foot sells its prostheses at the price of 30$. According to the consumption patterns mentioned above, a person at the BOP would have to save all his income designated to miscellaneous services during 2.5 to 6 months. (Michigan Business School, student case study: Jaipur Foot: Challenging Convention) 13 The example of the Jaipur Foot shows that lower limb prostheses must be adapted to the specific needs of the rural, agricultural population. To attain a sufficiently functional product, a high quality both in terms of material and design is necessary. (Michigan Business School, student case study: Jaipur Foot: Challenging Convention)
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The second aspect of co-inventing custom solutions is the business model. In India, a large share of the consumers at the bottom of the pyramid is geographically spread out into vast rural areas, which are not well accessible because of lack of infrastructure. Nevertheless, in order to sell in very large quantities, the distribution has to reach a national coverage. Additionally, as Karnani suggests, the cost of delivery is further increased by the small size of each transaction.14 In order to overcome these challenges, London and Hart suggest that the business model should involve multiple distributors. This participatory approach has the merit to reach out to rural areas and to raise the income of the distributors.15 For the MNC selling soaps, such a participatory approach involving multiple distributors makes sense. It could try to sell the soaps in village shops or through local entrepreneurs, as shown by the HLLs business model for the Annapurna salt, engaging local women entrepreneurs, so-called Shaktis.16 The soaps can therefore be made accessible in Indias poor rural areas. Combined with the facts that the product covers a basic need and is cheap, as seen above, a lot of people at the BOP will buy the soaps. In the case of the MNC selling prostheses, the participatory approach of distribution is not practicable. The fitting of lower limb prostheses requires very specific skills, which are not likely to be found in a sufficient number of villages. Consequently, as the product is not accessible easily, poor people would have to travel, which means additional costs for them. Having seen their extremely low income, it is therefore not probable, that this MNC will sell a high enough quantity of prostheses. In conclusion, the MNC selling soaps is more able to adopt a business model adjusted to the BOP than the MNC selling prostheses.

Finally, I come to the third dimension of strategic implications proposed by Prahalad and his associates. It refers to the non-market strategy of building a local base of support. As India is trying to promote its own MNCs, it is less receptive for foreign firms coming in. The Western MNCs therefore have to invest in alliances and raise goodwill among local authorities. A MNC which wants to leverage the size of the Indian BOP market has to be present in many Indian states. This increases the number of authorities at state-level which have to be dealt with. Such an extended non-market strategy again raises the cost of the venture. This is the case for both the MNC selling soaps as well as the one selling prostheses.

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Karnani, op. cit. London and Hart, op. cit. 16 Michigan Business School, student case study: Annapurna Salt: Public Health and Private Enterprise

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To conclude the analysis of the strategic implications of Prahalads approach, I would like to point out that altering the corporate strategy in order to sell to the poor does not work out for every MNC. Both the MNC selling soap and the one selling prostheses will have to face increased costs in their non-market strategy, particularly in order to establish partnerships and build a local base of support. However, in the case of the soap, the very low price and farreaching distribution allows for large volume sales. Therefore, the profits made through the market strategy can outweigh the costs caused by the adaption to the non-market environment. This is not the case for the prostheses venture: As the price cannot be reduced enough and accessibility is difficult, the product cannot be sold in a large enough quantity as to outweigh the costs of the venture. When analysing these corporate strategies in a Ghemawat17 framework, we can see that the MNC selling soap adopts a strategy focusing primarily on aggregation and arbitrage and a little bit on adaption. Contrariwise, the MNC selling prostheses has to emphasize on adaption and arbitrage, while not being able to reduce costs through aggregation, that is, economies of scale. According to Khanna and Palepu18, local firms in emerging markets face less adaption costs: They know the local market structure better, they tend to overcome distribution challenges more easily and they do not have to deal with institutional obstacles. Therefore, particularly the MNCs willing to sell products to the BOP which need a lot of adaption, will have to face the additional challenge of rivalry by local firms.

I conclude by stating that the BOP approach is profitable only for MNCs in certain sectors. In order for a MNC to be successful in the BOP market, it has to sell a product which corresponds to the basic needs of poor people, which can be sold at a very low price, does not have to be of high quality and can be made very accessible. Contrariwise, MNCs selling products which need a lot of adaption, are more expensive and less accessible do not have good prospects for gaining profits at the BOP. Furthermore, as local firms are better placed to sell products with a high degree of adaption, these latter MNCs will additionally face the threat of competition. Therefore, I maintain that whether or not a fortune can be made at the BOP depends very much on the type of product the MNC offers to the poor.

Ideas taken from: Ghemawat P., The Forgotten Strategy, 2003 Tarun Khanna and Krishna G. Palepu. "Emerging Giants: Building World-Class Competitors in Developing Countries", 2006
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Bibliography
Articles Ghemawat P., The Forgotten Strategy, Harvard Business Review, 2003 Hammond A. and Prahalad C.K., Selling to the Poor, Foreign Policy, May/June 2004 London T. and Hart S., Reinventing strategies for emerging markets: beyond the transnational model, Journal of International Business Studies, 2004 Karnani A., Mirage at the bottom of the pyramid, William Davidson Institute Working Paper Number 835, August 2006 Prahalad C.K. and Hart S., The Fortune at the Bottom of the Pyramid, Strategy and Competition, Issue 26, 2002 Prahalad C.K. and Hammond A., Serving the Worlds Poor, Profitably, Harvard Business Review, September 2002 Sachs D., The end of poverty, Time Magazine, March 2005 Tarun Khanna and Krishna G. Palepu. "Emerging Giants: Building World-Class Competitors in Developing Countries." Harvard Business Review. October 2006

Websites Michigan Business School, student case studies, http://www.bus.umich.edu/FacultyResearch/ResearchCenters/ProgramsPartnerships/ITChampions/default.htm World Bank figures from 2004, Povcal Net http://iresearch.worldbank.org/PovcalNet/jsp/index.jsp

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