All posts by Aneel Karnani

Markets of the Poor: Limits and Opportunities

Aneel KarnaniDr. Aneel Karnani is Associate Professor of Strategy, Ross School of Business, University of Michigan. His interests are focused on three topics: strategies for growth, global competition, and the role of business in society. He studies how firms can leverage existing competitive advantages and create new ones to achieve rapid growth. He is interested in global competition, particularly in the context of emerging economies. He studies both how local companies can compete against large multinational firms, and how multinational firms can succeed in these unfamiliar markets. Karnani researches poverty reduction and the appropriate roles for the private sector, the state and civil society. He is interested in how society can strike the appropriate balance between private profits and public welfare in tackling major societal problems.

The ‘base of the pyramid’ (BOP) proposition, famously popularized by C.K. Prahalad and other business gurus, assumes that there is much-untapped purchasing power at the base of the pyramid, and urges companies to make a fortune by serving the poor masses. The Economist magazine, given its market-oriented ideology, has been a strong advocate of the BOP proposition. On the opposite side, I have long been a skeptic, and in my book Fighting Poverty Together I argue that while private companies should try to market to the poor, the profit opportunities are modest at best and I suggest a cautious approach. In a recent article ‘The limits of frugality: Making things cheaper is not the same as making profits’ The Economist starts to walk back from its earlier support of the BOP proposition.

The Economist article acknowledges that it is politically correct for many executives to espouse the BOP proposition, because it serves an ideological purpose by showing that capitalism is inclusive, rather than only for the middle classes. “Whether their firms profit as a result is less clear.” The article goes on to cite examples of several firms in a variety of industries including mobile telephony, consumer goods, insurance, and consumer finance that have failed to profit from targeting the poor.

Contrary to the BOP literature, there are very few examples of profitable businesses that market socially useful goods in low-income markets and operate at a large scale. After an extensive survey in India of 270 market-based solutions to poverty, the consulting firm Monitor Group concluded “only a small handful – mostly well publicized ones like Grameen Bank and Aravind Eye Care – attained a scale sufficient to transform a ‘business model’ into a ‘solution’.” It is ironic, and instructive, that even both these examples are not really profitable businesses. The generous and well-intentioned social objectives of BOP initiatives must not hide the fact that these opportunities present tough economic and strategic challenges. The desire to do good should not blind managers to the realities of underlying economic forces that determine business success and failure.

There is no fortune at the base of the pyramid. Marketing socially useful products to the poor offers only limited business opportunities. Still, there are some profitable opportunities and we need creative entrepreneurs to design the right business models to serve the poor. It is necessary to understand that unmet needs do not necessarily constitute a market opportunity. A ‘market’ can exist only if there are buyers willing and able to pay a price that covers the total cost of production, including the opportunity cost of capital used. Unfortunately, due to the very meager income of the poor, markets for many socially useful goods simply do not exist. The French company Essilor found that not enough poor people were willing to pay even $5 for a pair of customized eyeglasses conveniently delivered on the spot. Procter & Gamble found that not enough poor people were willing to pay even $0.01 per liter for clean drinking water.

To serve the markets of the poor, firms have to dramatically reduce costs, by as much as 90 percent in many cases. A significant improvement in technology could reduce costs dramatically, as for example in telecommunications. Unfortunately there have not been such technological leaps in most other product categories. It is thus often necessary to reduce quality in order to reduce costs significantly. This does not imply selling shoddy or dangerous products. To profitably serve the poor, firms need to make the cost-quality trade-off appropriately in order to make the products affordable by the poor; the challenge is to do this in such a way that the cost-quality trade-off is acceptable to poor consumers. A simple or minor adaptation of the business model from affluent markets usually results in products that are too expensive and not affordable by the poor.
Selling low quality products to the poor might seem unethical. But in fact, selling products at the appropriate cost-quality trade-off is not only ethical, it is socially virtuous. The appropriate reference point for quality is not the standard prevailing in affluent markets, but rather the status quo in BOP markets, which usually is unfulfilled basic needs. A low quality product is better than no product at all.

A good example of this logic is the low-price detergent successfully marketed by Nirma in India. The quality of Nirma is clearly inferior to that of Surf, the product marketed by Unilever. Nirma contains no active detergent, whitener, perfume, or softener. Indeed tests performed on Nirma confirmed that it was hard on the skin and could cause blisters. It seems the poor like inexpensive, low-quality products. This is not because they cannot appreciate or do not want good quality. They simply cannot afford the same quality products as the affluent; so, they have a different price-quality trade-off. They are even willing to put up with a detergent that sometimes causes blisters! The standards to judge what is acceptable have to be from the perspective of a poor person who before could not afford any detergent, and not from the perspective of an affluent person who routinely buys a high-quality detergent.

The biggest difference between BOP and affluent markets is the obvious but under-emphasized fact that the poor have very low purchasing power. Designing business models to serve markets of the poor has to start with this basic insight rather than a minor adaptation of the business models successful in affluent markets.

Ganging Up on Poverty

Aneel KarnaniDr. Aneel Karnani is Associate Professor of Strategy, Ross School of Business, University of Michigan. His interests are focused on three topics: strategies for growth, global competition, and the role of business in society. He studies how firms can leverage existing competitive advantages and create new ones to achieve rapid growth. He is interested in global competition, particularly in the context of emerging economies. He studies both how local companies can compete against large multinational firms, and how multinational firms can succeed in these unfamiliar markets. Karnani researches poverty reduction and the appropriate roles for the private sector, the state and civil society. He is interested in how society can strike the appropriate balance between private profits and public welfare in tackling major societal problems.

This is an interview based on his book “Fighting Poverty Together: Rethinking Strategies for Business, Governments, and Civil Society to Reduce Poverty” he gave to iMpact of the University of Michigan. Prof. Karnani authorized us to publish it in the Business Thinker.

Despite global efforts to alleviate poverty in the past half century, it remains a vexing social problem. Livable wages and lack of access to the basics — clean drinking water, sanitation, roads, and security — remain far too elusive for far too many. Recent efforts such as microfinance and base of the pyramid (BoP) ventures may generate attention, but they don’t achieve the objective, says strategy professor Aneel Karnani. Efforts should instead focus on ensuring that governments provide access to essential services while creating a climate in which businesses create jobs. Nonprofits, meanwhile, should serve as catalysts and watchdogs.
In his book, Fighting Poverty Together: Rethinking Strategies for Business, Governments, and Civil Society to Reduce Poverty (Palgrave Macmillan), Karnani argues this alignment across multiple sectors is critical for raising the incomes of the poor.

In the following Q&A, Karnani discusses why he thinks this approach is more effective than microfinance and BoP outreach.

Q: What motivated you to write a book on fighting poverty?

Karnani: I’ve been at the business school for 30 years. And for the first 20 I did the traditional things — teaching, research, and consulting, all focused on competitive strategy. But in the last 10 years, as I get older and more philosophical, my interests have broadened. Rather than studying how companies can get a competitive advantage and make more money, my interests have shifted more to the role of business in society, how society tackles larger problems, what the tradeoffs are, and how we manage these tradeoffs. I hear a lot of executives these days talking about corporate social responsibility and asking, ‘What is the role of business in solving these problems?’ When I talked to MBA students 20 years ago, most of them just wanted to go into consulting or investment banking and make money. Now many of them want to influence the world and have an impact on social issues. So all of these factors came together and my own interests shifted in that direction.
The second motivation is that when I hear other people talking about these social issues — whether it’s business people or academics — they all talk about win-win, feel-good solutions. I’m very skeptical that we’ll all be able to hold hands, sing, and solve the world’s problems. I see major tradeoffs in the world, and the whole field of economics is about how to manage tradeoffs. So I wanted to come at this with a more critical approach in terms of questioning popular perspectives.

Q: In the book you question the more recent solutions to poverty alleviation, including one that has a real home here at Ross — the BoP approach. Why do you think these recent attempts, notably microfinance and BoP, have fallen short both philosophically and on the ground?

Karnani: The major problem with microfinance is an underlying assumption that poor people want to be entrepreneurs. It also assumes they have the skills and drive to be entrepreneurs. I think this is a major fallacy. What’s an entrepreneur? It’s a person who has creativity, drive, persistence, and vision, who manages to bring an innovation to market, create value, and bring a new business model to the table. It is wonderful when people have entrepreneurial skills, and some of them do, but to expect a large majority of people to have them is not realistic.
If you look at a rich, advanced country like the U.S., more than 90 percent of the workforce is on a salary. If 90 percent of the people in the U.S. don’t want to be entrepreneurs, why do we think poor people in emerging countries want to be entrepreneurs? If you ask a poor person, ‘What’s the one thing you would like,’ I think the most common answer is, ‘A job at a reasonable salary.’
The second problem is that the bulk of microcredit isn’t used to fund a business. The bulk is used to finance consumption. That cannot increase your income in the future and, in fact, it can decrease your future income.
The third problem is that microcredit, even when it’s used to finance a business, usually does so in a highly competitive sector. The entry barriers are low, not much skill is required, and there’s no physical capital or assets. Profits are low and they just don’t earn enough. To top it off, the interest rates on microcredit are very high. The rates are often 50 percent, and in some cases 80 to 90 percent, effectively. It’s a rare business that’s going to get a rate of return on investment of 80 to 90 percent. So you put all of this together and microcredit is not going to lift people out of poverty.

Q: You mentioned that the poor, along with having low incomes, have vulnerable incomes. Does microcredit, microfinance, address that?

Karnani: No. It doesn’t do anything to change the vulnerability of a person’s income. The only good purpose it serves is that it can smooth out the consumption. As a poor person, if you earn a lot today but not tomorrow, a loan can help you smooth out the gaps. But even with that, it’s doing it at a very high price. What the poor need instead are microsavings accounts rather than microcredit. The trouble with microsavings is that the cost of providing the account is too high and nobody can do it today on a for-profit basis. There are a few NGOs offering microsavings, but it’s a very small part of the industry.
My argument is not just theoretical. There is now empirical evidence that shows microcredit does not help. I don’t know if it hurts or not, but we are putting a lot of resources into it and not getting enough impact out of it. So as a world, we can put those resources to better use in helping the poor.

Q: Why do you think the BoP approach doesn’t work?

Karnani: The thrust of the BoP logic is to sell things to the poor that are profitable and simultaneously will help alleviate poverty. I think this basic logic is very problematic. A poor person is not going to become better off by consuming more. He’s going to become better off by producing more. So I think the starting point is key: Treat poor people as producers, not as consumers. I think the BoP logic focuses too much on consumption and too much on large, multinational companies rather than small- and mid-size enterprises that are the engine of economic value creation in emerging countries. After years of exploring the BoP approach, we still don’t have good examples of how well this is working. I think it’s interesting and not accidental that the most celebrated example used by BoP proponents is Aravind Eye Care, which is a nonprofit organization.

Q: But the BoP proponents have recognized that this is a difficult challenge. They never expected it to be a success overnight, and agree there haven’t been homeruns. One of the things they’ve noted is that early BoP ventures focused on market entry, not market creation. For example, in your book you laud the example of TechnoServe, an NGO that facilitated a rebirth of the cashew-growing industry in Mozambique. That looks like market creation so wouldn’t that be along the lines of a BoP 2.0 venture? Certainly there is a role for NGOs in the BoP model.

Karnani: It’s true that Stuart Hart and (Ross professor) Ted London (authors of Next Generation Strategies for the Base of the Pyramid: New Approaches for Building Mutual Value) are critical of the early BoP ventures. But I think there is a difference when you talk about market creation. The difference is this: In the market created, who is the consumer? Even the BoP 2.0 literature is still talking about the poor as the consumers with that market creation. Whereas in the TechnoServe example I used, the consumers are people like you and me who are eating the cashew nuts. The poor are selling the cashew nuts, they’re not eating them. The fundamental issue here, which is absolutely central, is that if you want to help the poor people you have to treat them more as producers than consumers. What is the defining characteristic of a poor person? Low income. Let’s increase their income. The way to do that is to provide jobs, increase their productivity, increase their education, increase their access to markets.
I’m not dismissing the BoP logic totally. We have to try to sell things to the poor that are truly good for them at a price they can afford. I think both of those are critical points. We need to ensure these are prices the poor can truly afford and that the products serve high priority needs, such as housing, basic nutrition, healthcare, education, and clean drinking water. The trouble is there aren’t too many successful examples of that. I have several examples in the book of companies trying to sell things to the poor that are beneficial and high priority, like nutritious yogurt and clean drinking water. But it’s very hard to make it cheap enough where the poor can truly afford it and where the company will make a profit. But we can find some positive examples, like Nirma (the Indian detergent company) and mobile phones.

Q: It sounds like that’s a philosophical difference between your position and the BoP position. They might argue that selling a low-quality product to the poor is exploitative. You think taking the time to create high-quality products they can afford isn’t necessary.

Karnani: That is a big difference. The way to resolve it is to find enough examples, and I just don’t see that many examples where you can keep quality high and reduce the price dramatically and make a profit by selling to the poor. I think it’s disrespectful to the poor to say, ‘Let’s wait and find a way to do it.’ We can’t keep waiting. Let’s do what needs to be done now.

Q: Let’s talk about your framework. In a nutshell, you want to use the engine of business to push job creation, while governments provide the proper landscape with a legal framework and infrastructure to make that happen. At the same time nonprofits, or NGOs, will facilitate the connections and serve as watchdogs. Why is that more effective?

Karnani: To reduce poverty we have to increase the income of the poor and the best way to do that is to provide jobs. In fact, the International Labor Organization says nothing is as fundamental to poverty reduction as job creation. The last 50 to 60 years shows conclusively that business is the best engine of job creation. We’ve seen countries try communism and heavy-handed government intervention in the economy and we know that we need markets and private enterprise to create jobs. But you just can’t tell a private company to create jobs. Private companies will create jobs when it’s in their self-interest to do so.
What society needs to do, especially the government, is to foster job creation, employment growth, and business growth. The World Bank has a useful project called Doing Business Right that analyzes what’s needed to foster business growth and job creation — things such as reasonable regulation, property rights, and infrastructure. The role of business is to create jobs and the role of the government is to create the environment for this to happen. Unfortunately, many emerging countries have not done that in the past. In fact, they have often had policies that stifle business. We need to change that.
NGOs can play a role as a catalyst. Sometimes markets don’t work very well and NGOs can play a role in un-sticking these markets. A good example of that is TechnoServe, which is a mid-size NGO. All it does is emphasize job creation. It helps local entrepreneurs who are sort of stuck. TechnoServe doesn’t create the business, it just helps get rid of the bottlenecks, and it’s doing it very well.
I think we should concentrate our efforts on job creation among small- to mid-scale enterprises. And this is where I differ with the BoP logic, which I think emphasizes big, multinational companies. But if you look at even a rich country like the U.S., more than 60 percent of employment is in the small- to mid-scale enterprises. If you go to countries like India, what you see is a polarized economy. There are a lot of microenterprises, there are large enterprises, but the mid-size enterprises are missing. It’s these midscale enterprises that are the engine of job growth. I think countries like India need to encourage the growth of small to mid-scale businesses rather than microcredit at the bottom and large companies at the top.
The second area where we should focus our efforts is on the people who are getting the jobs. I think we should focus our efforts on the youth, say from 16 to 25 years. If you don’t get this young person a job, it has a lifelong impact on this person. If this young person is not given a proper job by the age of 25, he or she will probably go on the wrong track.

Q: What else does government need to do besides foster job creation?

Karnani: Next to a job, the poor need basic public services — education, clean water, sanitation, roads, public health, vaccinations, and public security. Those are the basics of life. Without that, very little else is going to work. Even a job isn’t much use if a child is dying of malaria or diarrhea. In many poor countries, the government has failed miserably at this. I don’t have a magic formula for doing it but we know it can be done. In some poor countries there are hopeful signs. I think we need the public will to do it. One of my objectives in the book is to present the facts, to provide some stimulation leading to rage that we shouldn’t accept the status quo as inevitable. We should say it’s essential that we provide clean drinking water to poor people. In some countries, like India now, there is a movement called the rights-based approach to development. It is the moral right of every human being to have access to the basics of life.

Q: Poverty is such a long-term problem and we’ve seen such slow progress despite tremendous economic growth in some sectors. Is it hard to get people enraged and engaged?

Karnani: I think we haven’t tried the right policies. You can’t do it with business alone. But governments alone can’t do it, either. We need to find the right balance. That’s why the title of my book is Fighting Poverty Together. There’s a role for business, there’s a role for government, and there’s a role for civil society. We need to understand these roles and everybody needs to do their share. One thing that is different now is that poverty and affluence have come closer together physically. You see slums right next to rich neighborhoods; the media expose us to poverty everyday. This is not a stable situation. The rich and the middle class just cannot turn a blind eye to poverty. Our sense of social and moral justice does not let us tolerate such pervasive and desperate poverty. My objective is to stimulate a public debate leading to action. This book is meant for smart people with a conscience. You don’t have to be an economist or a business expert. I think we should all be engaged in this debate. Business schools, companies, trade organizations, civil society and governments are in fact engaged in a widespread dialogue. I am hopeful that this dialogue will lead to both private and public action to reduce poverty.