Dr. 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.