Eliminating the ‘poverty premium’

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Companies that want to get a foothold in the bottom of the market pyramid, need to understand all the factors that a poor person considers before making a purchase.

In 2006, a company called Solae began selling soy protein powder in the slums of Mumbai. Solae, a subsidiary of DuPont, saw an opportunity to gain a toehold in the Indian consumer market while addressing malnutrition — a classic case of “doing well by doing good.” It expected the product to be a big success. Yet by 2008, the venture had failed. The soy protein, which cost 30 cents a packet, couldn’t compete on price with lentils, the staple protein in many Mumbaikars’ diets, which cost less than half as much for an equivalent serving.

Solae is not the only company to make this kind of miscalculation. In 2000 Procter & Gamble introduced PUR, a line of water filtration sachets for low-income, developing-country households, and in 2006 Grameen Danone began selling packaged yogurt in rural Bangladesh. Neither product gained traction in those markets. All three firms were misled by a common fallacy: that poor people in emerging markets pay a “poverty premium” on everyday goods, and that multinational corporations can develop products to close the price gaps.

The concept of a poverty premium was first outlined in a 2002 Harvard Business Review article by C.K. Prahalad and Allen Hammond that described the benefits multinationals could gain by serving poor consumers in emerging markets. “Consumers at the bottom of the pyramid pay much higher prices for most things than middle-class consumers do, which means that there’s a real opportunity for companies, particularly big corporations with economies of scale and efficient supply chains, to capture market share by offering higher-quality goods at lower prices,” the authors wrote. They cited inefficient distribution, low competition and excessive mark-ups as the causes of the premium.

But today the poverty premium often seems to be illusory. Sometimes new products fail because traditional products or practices provide a cheaper option. In other cases, the prices of competing goods have dropped, or residents have found clever (or illegal) ways to obtain goods cheaply. Our research suggests that companies hoping to reach low-income consumers need to understand what their innovations would compete against.

We reached this conclusion after surveying prices in two very different parts of Mumbai. Dharavi, with 600,000 people, is one of the world’s largest slums. The median income is about $100 a month. The area has no large retailers; most goods are sold in “kirana” shops — small, non-air-conditioned convenience stores that negotiate prices and deal only in cash. Nine kilometres to the south lies the upmarket district of Warden Road. It boasts a variety of brand-name retailers, from high-end jewellery merchants to gelato shops. The consumer experience there is comparable to that in any developed economy: Stores are air-conditioned, prices are fixed and credit cards are accepted.

In January 2013, we visited 17 stores in Dharavi and 17 in Warden Road, comparing the prices of 40 products. We also examined the cost of various services, including water, electricity and mobile phone service. We found that Mumbai’s poor do not pay more than the city’s affluent for everyday products. In most cases, they pay less, enjoying a substantial “poverty discount” on basic foodstuffs, doctor’s appointments, and luxury items such as movie tickets and meals out.

These findings directly contradict the poverty premium’s argument that food “costs 20-30 per cent more in the poorest communities since there is no access to bulk discount stores.” Neither the cost assertion nor the explanation holds true today in India, though they may elsewhere. A low-income family in, say, New York’s South Bronx, which has few discount or grocery stores, pays more for basic goods than a middle-class family in a suburb where such stores are plentiful. In India, however, the reverse is true: The corner shop is both the cheapest and the most convenient option.

How is this possible? Dharavi’s stores are part of the informal economy, meaning they pay no taxes or licence fees and can give workers less than the minimum wage. And they’re so numerous that they create near-perfect competition, which limits pricing power. In contrast, the relatively small number of Warden Road retailers produces an oligopolistic pricing dynamic.

In some cases, market development or innovation has erased poverty premiums. For example, poor consumers once paid high interest rates owing to a shortage of formal lenders, but over the past decade State banks and microfinance institutions have opened branches in Dharavi and made credit available at competitive rates. In other cases, State intervention has lowered costs for the poor: India’s Public Distribution System subsidises rice, wheat, kerosene and other goods through its “fair price shops.” In still other cases, illegal practices or black markets play a role.

To be sure, Dharavi residents and Warden Road shoppers pay similar amounts for some goods. The government controls the flow of basic commodities, so those have uniform prices. And manufacturers in India can specify a “maximum retail price” for their packaged branded goods. But for some products and services, the cheaper prices in Dharavi reflect lower quality, an inferior user experience or poor access. For example, unpackaged lentils and grains are likely to be less hygienic than packaged varieties.

Low-quality produce is often sent to Dharavi rather than to upmarket areas. A hairdresser in Dharavi has had less formal training than one in Warden Road. Such quality differentials suggest that there is room for private-sector intervention, but probably not based on price.

Multinationals that failed to take these realities into account saw their best-laid business plans go bust. P&G’s PUR sachets were envisioned as a low-priced competitor to bottled water; in reality, though, poor households are used to boiling their tap water or drinking it untreated. Grameen Danone’s real competition among rural populations wasn’t expensive store-bought yogurt — it was homemade yogurt that consumers produced for a fraction of the cost.

But in places where poor consumers benefit from lower prices, they often incur other costs. For example, the informal economy fails to ensure safe working conditions and reasonable wages, product quality controls or taxes for the State. The brunt of these externalities is borne by the poor, as workers, consumers and beneficiaries of government funds.

Such places may have a “poverty premium” that multinationals could help eliminate, but that premium does not take the form of higher prices.

Bringing affordable products to poor consumers can be a noble calling. Multinationals need to be aware, however, of how hard it can be to compete on the basis of price. Existing prices may be much lower than they think, and local practices that aren’t obvious to outsiders may influence product adoption. Companies need to develop a nuanced, on-the-ground understanding of all the factors poor consumers consider when making purchasing decisions. Otherwise, they’re apt to learn the painful lesson that serving a bottom-of-the-pyramid market today is trickier than the theory suggests.

Ethan Kay is the managing director of emerging markets at BioLite, a firm that develops cook stoves for sub-Saharan Africa and Asia, and a doctoral student at Oxford University. Woody Lewenstein recently completed a master's degree at King's College London.

© 2013 Harvard Business School Publishing Corp.




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