Monday, August 13, 2007

The guidance at the bottom of the pyramid?

(Moussa Keita and Rian Aldridge install a wireless antenna in Bamako)

Being a newcomer to the world of developmental finance C.K. Prahalad's book The Fortune at the Bottom of the Pyramid was very useful in helping me to understand what takes place in under developed markets. I have listed verbatim some of the takeaways I used from the book. I have also tried to adapt some of Prahalad's model to better suit smaller markets. As always I am simply giving my interpretation of the authors work, and I am always open to feedback.

In The Fortune at the Bottom of the Pyramid, C.K. Prahalad proposes that there is a vast, untapped market that exists in developing nations with large populations. Prahalad argues that this market opportunity has remained untapped because multinational corporations have to rethink traditional business models to exploit the opportunity profitably.

“The BOP, as a market, will challenge the dominant logic of MNC managers (the beliefs and values that managers serving the developed markets have been socialized with). For example, the basic economics of the BOP market are based on small unit packages, low margin per unit, high volume, and high return on capital employed. This is different from large unit packs, high margin per unit, high volume, and reasonable return on capital employed.”­ – C.K.Prahalad, The Fortune at the Bottom of the Pyramid.

Prahalad suggests 12 principles to serve as “the building blocks of a philosophy of innovation for BOP markets.” They are listed below:[1]
1) Focus on price performance of products and services
2) Innovation requires hybrid solutions. BOP consumer problems cannot be solved with old technologies
3) As BOP markets are large, solutions that are developed must be scalable and transportable across countries, cultures, and languages
4) All innovations must focus on conserving resources: eliminate, reduce, and recycle
5) Product development must start from a deep understanding of functionality, not just form
6) Process innovations are just as critical in BOP markets as product innovations.
7) Deskilling work is critical
8) Education of customers on product usage is key
9) Products must work in hostile environments
10) Research on interfaces is critical given the nature of the consumer population.
11) Innovations must reach the consumer (both highly dispersed rural market and a highly dense urban market)
12) Paradoxically, the feature and function evolution in BOP markets can be very rapid. Product developers must focus on the broad architecture of the system – the platform – so that new features can be easily incorporated.

When I read these principles of innovation I understood the message but wondered if the model is applicable to countries such as Mali due to their lack of population density. While Prahalad addresses the need to serve the urban market he is mainly addressing the need for MNCs to explore all markets in countries like China so that massive populations may be fully reached. In areas of lesser population density, investment by MNCs is harder to justify but these markets still need to be served. As Prahalad proposes, a fundamental rethink must occur however in the case of smaller countries investment may need to be approached in terms of regional expansion.

Brazil, Russia, India and China (BRIC) are often looked to as examples of the economic potential of emerging markets. However the economies of these countries are not representative of all emerging markets. Each of these countries has large populations; Russia has the fewest people with approximately 141 million[2]. Each of these countries is very large in terms of area; India is the smallest with approximately 3.2 million square kilometers[3]. The average GDP of the BRIC countries is $4.43 trillion; China’s economy is particularly large with a GDP of over $10 trillion[4]. These countries are used as the benchmark for emerging market investment but I believe looking to these markets may blind us to other opportunities.

If investment is made on the basis of returns on extremely high volumes in a dense area, with a relatively large consumer buying power (on aggregate), how do small nations attract investors? In other words, if we condition MNCs and individual investors to use size and returns on size as the acid-test for investment into developing markets we condition them to believe that all sites failing the acid-test are not worthy of investment when this may not be the case. For example Mali exhibited a 5.1% real growth rate in 2006[5] but given as an absolute dollar amount the Malian economy is this growth is fractional when compared to growth in any of the BRIC countries. However looking at a group of West African countries we can see how thinking regionally can help identify opportunities: Mali, Senegal, Cote D’Ivoire, Liberia, Guinea-Bissau, Guinea, Gambia, Burkina Faso, Togo and Benin. The population of these nations combined is approximately 86 million, and has a greater population density than either of Russia or Brazil[6]. I am not trying to suggest that anyone should invest in each of these countries simultaneously but thinking regional helps to identify opportunities, which are otherwise not feasible. Because these markets must be considered in a unique way, opportunity must also be evaluated in a unique way. Factors such as ability to adapt to numerous markets and to provide a high level of price performance are extremely important. Sustainable business practices including human resource development are important to both financial success and to social impact.

The need to identify opportunities in Africa in non-traditional ways caused us to incorporate the ideas put forth by Prahalad with our own ideas of success factors in these markets. Below are the evaluative criteria we have developed for identifying companies that represent potentially profitable opportunities for equity investors.

[1] The Fortune at the Bottom of the Pyramid – C.K. Prahalad, © 2005 Pearson Education, Inc. Wharton School Publishing, Upper Saddle River, NJ 07458
[2] CIA World Fact Book Online
[3] CIA World Fact Book Online
[4] CIA World Fact Book Online
[5] Estimate - CIA World Fact Book Online

[6] CIA World Fact Book Online

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