Harvard Business School Working Knowledg e Archive

Serving the World's Poor, Profitably - The Payoff for Investing in Poor Countries

11/18/2002

Consider this bleak vision of the world fifteen years from now: The global economy recovers from its current stagnation but growth remains anemic. Deflation continues to threaten, the gap between rich and poor keeps widening, and incidents of economic chaos, governmental collapse, and civil war plague developing regions. Terrorism remains a constant threat, diverting significant public and private resources to security concerns. Opposition to the global market system intensifies. Multinational companies find it difficult to expand, and many become risk averse, slowing investment and pulling back from emerging markets.

Now consider this much brighter scenario: Driven by private investment and widespread entrepreneurial activity, the economies of developing regions grow vigorously, creating jobs and wealth and bringing hundreds of millions of new consumers into the global marketplace every year. China, India, Brazil, and, gradually, South Africa become new engines of global economic growth, promoting prosperity around the world. The resulting decrease in poverty produces a range of social benefits, helping to stabilize many developing regions and reduce civil and cross-border conflicts. The threat of terrorism and war recedes. Multinational companies expand rapidly in an era of intense innovation and competition.

Both of these scenarios are possible. Which one comes to pass will be determined primarily by one factor: the willingness of big, multinational companies to enter and invest in the world's poorest markets. By stimulating commerce and development at the bottom of the economic pyramid, MNCs could radically improve the lives of billions of people and help bring into being a more stable, less dangerous world. Achieving this goal does not require multinationals to spearhead global social development initiatives for charitable purposes. They need only act in their own self-interest, for there are enormous business benefits to be gained by entering developing markets. In fact, many innovative companies—entrepreneurial outfits and large, established enterprises alike—are already serving the world's poor in ways that generate strong revenues, lead to greater operating efficiencies, and uncover new sources of innovation. For these companies—and those that follow their lead—building businesses aimed at the bottom of the pyramid promises to provide important competitive advantages as the twenty-first century unfolds.

Big companies are not going to solve the economic ills of developing countries by themselves, of course. It will also take targeted financial aid from the developed world and improvements in the governance of the developing nations themselves. But it's clear to us that prosperity can come to the poorest regions only through the direct and sustained involvement of multinational companies. And it's equally clear that the multinationals can enhance their own prosperity in the process.

Untapped potential
Everyone knows that the world's poor are distressingly plentiful. Fully 65 percent of the world's population earns less than $2,000 each per year—that's 4 billion people. But despite the vastness of this market, it remains largely untapped by multinational companies. The reluctance to invest is easy to understand. Companies assume that people with such low incomes have little to spend on goods and services and that what they do spend goes to basic needs like food and shelter. They also assume that various barriers to commerce—corruption, illiteracy, inadequate infrastructure, currency fluctuations, bureaucratic red tape—make it impossible to do business profitably in these regions.

But such assumptions reflect a narrow and largely outdated view of the developing world. The fact is, many multinationals already successfully do business in developing countries (although most currently focus on selling to the small upper-middle-class segments of these markets), and their experience shows that the barriers to commerce—although real—are much lower than is typically thought. Moreover, several positive trends in developing countries—from political reform, to a growing openness to investment, to the development of low-cost wireless communication networks—are reducing the barriers further while also providing businesses with greater access to even the poorest city slums and rural areas. Indeed, once the misperceptions are wiped away, the enormous economic potential that lies at the bottom of the pyramid becomes clear.

Such assumptions reflect a narrow and largely outdated view of the developing world.
— C. K. Prahalad and Allen Hammond

Take the assumption that the poor have no money. It sounds obvious on the surface, but it's wrong. While individual incomes may be low, the aggregate buying power of poor communities is actually quite large. The average per capita income of villagers in rural Bangladesh, for instance, is less than $200 per year, but as a group they are avid consumers of telecommunications services. Grameen Telecom's village phones, which are owned by a single entrepreneur but used by the entire community, generate an average revenue of roughly $90 a month—and as much as $1,000 a month in some large villages. Customers of these village phones, who pay cash for each use, spend an average of 7 percent of their income on phone services—a far higher percentage than consumers in traditional markets do.

It's also incorrect to assume that the poor are too concerned with fulfilling their basic needs to "waste" money on nonessential goods. In fact, the poor often do buy "luxury" items. In the Mumbai shantytown of Dharavi, for example, 85 percent of households own a television set, 75 percent own a pressure cooker and a mixer, 56 percent own a gas stove, and 21 percent have telephones. That's because buying a house in Mumbai, for most people at the bottom of the pyramid, is not a realistic option. Neither is getting access to running water. They accept that reality, and rather than saving for a rainy day, they spend their income on things they can get now that improve the quality of their lives.

While individual incomes may be low, the aggregate buying power of poor communities is actually quite large.
— C. K. Prahalad and Allen Hammond

Another big misperception about developing markets is that the goods sold there are incredibly cheap and, hence, there's no room for a new competitor to come in and turn a profit. In reality, 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 while maintaining attractive margins. In fact, throughout the developing world, urban slum dwellers pay, for instance, between four and 100 times as much for drinking water as middle- and upper-class families. Food also costs 20 percent to 30 percent more in the poorest communities since there is no access to bulk discount stores. On the service side of the economy, local moneylenders charge interest of 10 percent to 15 percent per day, with annual rates running as high as 2,000 percent. Even the lucky small-scale entrepreneurs who get loans from nonprofit microfinance institutions pay between 40 percent and 70 percent interest per year—rates that are illegal in most developed countries. (For a closer look at how the prices of goods compare in rich and poor areas, see the exhibit "The High-Cost Economy of the Poor.")

It can also be surprisingly cheap to market and deliver products and services to the world's poor. That's because many of them live in cities that are densely populated today and will be even more so in the years to come. Figures from the UN and the World Resources Institute indicate that by 2015, in Africa, 225 cities will each have populations of more than 1 million; in Latin America, another 225; and in Asia, 903. The population of at least 27 cities will reach or exceed 8 million. Collectively, the 1,300 largest cities will account for some 1.5 billion to 2 billion people, roughly half of whom will be bottom-of-the-pyramid (BOP) consumers now served primarily by informal economies. Companies that operate in these areas will have access to millions of potential new customers, who together have billions of dollars to spend. The poor in Rio de Janeiro, for instance, have a total purchasing power of $1.2 billion ($600 per person). Shantytowns in Johannesburg or Mumbai are no different.

The slums of these cities already have distinct ecosystems, with retail shops, small businesses, schools, clinics, and moneylenders. Although there are few reliable estimates of the value of commercial transactions in slums, business activity appears to be thriving. Dharavi—covering an area of just 435 acres—boasts scores of businesses ranging from leather, textiles, plastic recycling, and surgical sutures to gold jewelry, illicit liquor, detergents, and groceries. The scale of the businesses varies from one-person operations to bigger, well-recognized producers of brand-name products. Dharavi generates an estimated $450 million in manufacturing revenues, or about $1 million per acre of land. Established shantytowns in SĂŁo Paulo, Rio, and Mexico City are equally productive. The seeds of a vibrant commercial sector have been sown.

Clearly, poor communities are ready to adopt new technologies that improve their economic opportunities or their quality of life.
— C. K. Prahalad and Allen Hammond

While the rural poor are naturally harder to reach than the urban poor, they also represent a large untapped opportunity for companies. Indeed, 60 percent of India's GDP is generated in rural areas. The critical barrier to doing business in rural regions is distribution access, not a lack of buying power. But new information technology and communications infrastructures—especially wireless—promise to become an inexpensive way to establish marketing and distribution channels in these communities.

Conventional wisdom says that people in BOP markets cannot use such advanced technologies, but that's just another misconception. Poor rural women in Bangladesh have had no difficulty using GSM cell phones, despite never before using phones of any type. In Kenya, teenagers from slums are being successfully trained as Web page designers. Poor farmers in El Salvador use telecenters to negotiate the sale of their crops over the Internet. And women in Indian coastal villages have in less than a week learned to use PCs to interpret real-time satellite images showing concentrations of schools of fish in the Arabian Sea so they can direct their husbands to the best fishing areas. Clearly, poor communities are ready to adopt new technologies that improve their economic opportunities or their quality of life. The lesson for multinationals: Don't hesitate to deploy advanced technologies at the bottom of the pyramid while, or even before, deploying them in advanced countries.

A final misperception concerns the highly charged issue of exploitation of the poor by MNCs. The informal economies that now serve poor communities are full of inefficiencies and exploitive intermediaries. So if a microfinance institution charges 50 percent annual interest when the alternative is either 1,000 percent interest or no loan at all, is that exploiting or helping the poor? If a large financial company such as Citigroup were to use its scale to offer microloans at 20 percent, is that exploiting or helping the poor? The issue is not just cost but also quality—quality in the range and fairness of financial services, quality of food, quality of water. We argue that when MNCs provide basic goods and services that reduce costs to the poor and help improve their standard of living—while generating an acceptable return on investment—the results benefit everyone.

Excerpted with permission from "Serving the World's Poor, Profitably," Harvard Business Review, Vol. 80, No. 9, September 2002.

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C.K. Prahalad is the Harvey C. Fruehauf Professor of Business Administration at the University of Michigan Business School in Ann Arbor, and the chairman of Praja, a software company in San Diego.

Allen Hammond is the CIO, senior scientist, and director of the Digital Dividend project at the World Resources Institute in Washington, DC.

Related special reports in HBS Working Knowledge:
Social Enterprise Internships 2002

Globalization: Doing Business in a New World

Related HBS initiatives:
Initiative on Social Enterprise

The High-Cost Economy of the Poor

When we compare the costs of essentials in Dharavi, a shantytown of more than 1 million people in the heart of Mumbai, India, with those of Warden Road, an upper-class community in a nice Mumbai suburb, a disturbing picture emerges. Clearly, costs could be dramatically reduced if the poor could benefit from the scope, scale, and supply-chain efficiencies of large enterprises, as their middle-class counterparts do. This pattern is common around the world, even in developed countries. For instance, a similar, if less exaggerated, disparity exists between the inner-city poor and the suburban rich in the United States.

CostDharaviWarden Road Poverty premium
Credit (annual interest)600 percent-1,000 percent12 percent-18 percent53X
municipal-grade water (per cubic meter)$1.12$0.03>37X
phone call (per minute)$0.04-$0.05$0.0251.8X
diarrhea medication$20$210X
rice (per kilogram)$0.28$0.241.2X