NextBillion - An Initiative of the William Davidson Institute at the University of Michigan

This post tries to correct a missed opportunity in the BoP space: the analysis and categorization of firms in low-income markets from an industry basis. From a sociological standpoint, when we categorize firms as belonging to a specific industry we do it to make better sense of the diversity of firms in the real world. When we lump things together we carve “islands of meaning” (Zerubavel, 1996) that, in spite of not being logical, are useful to analyze and understand the reality that surrounds us.

These “islands of meaning” come at the cost of simplifying reality and can result in biased judgments of a firm working in more than one industry. For instance, it has been shown that security analysts regularly penalize in their valuations those firms which straddle industry boundaries (Zuckerman, 2000). Such penalization is independent of the firm economic performance or its strategy. It arises because straddling or diversified firms are more difficult to analyze and understand since they do not conform to this ready-made categorization. I believe we often make the same mistake in BoP markets and that this mistake is more serious than in developed markets.

To see why this is a mistake, forget for a second that a firm may belong to a particular industry. Consider instead that, first, at the firm level, many of the most successful business models in low-income markets (from economic and social perspectives) are hybrids and hence straddle different industries. Therefore, by focusing on developing business models that may squarely fit on one industry we are decreasing our chances of maximizing our impact in these markets. The best-known case of hybrid business models is probably mobile phone banking, although important developments have made in health services offered through IT platforms and multi-product selling using the same commercial platform to take advantage of the platform’s capillarity and information.

Second, at the household level, potential consumers are extremely cash constrained. It is generally argued that as a result, if a customer increases her purchases in one product, she will have to decrease expenditures on other products. However, what is usually overlooked is that the purchase and consumption of a good can in fact result in additional expenditures one other types of goods which are traditionally within the scope of other industries. This positive domino effect has been shown in, for example, households buying mobile phones and as a result increasing their expenditures on other basic goods thanks to better information access (Jensen, 2007).

By approaching low-income firms using our “industry-glasses”, we become blind to a portion of the true potential of the private sector in developing countries. Indeed, it is likely that we are becoming blind to the most promising aspect of private sector solutions. Take, for instance, the case of utility retailers. Utility retailers are usually not especially exciting for BoP entrepreneurs or investors because of the high-fixed costs required to set up these firms. Instead, decentralized energy services are often favored, such as setting up solar panels or pedal-powered water pumps. Moreover, these solutions avoid dependence on the state and, if households are connected to the grid, they may even make some money by selling unused energy.

The problem with this analysis is that it fails to consider the relationship between utility relaters and other industries. At the firm level, using a “multi-industry” approach can result in important findings. Utility retailers have developed extensive platforms to cater to particular areas and generate potentially useful billing information about their customers. For instance, witness, the case of Codensa. After improving its energy losses and its infrastructure management, it used its customer information and its privileged access to customers to offer credits for the acquisition of electrical appliances (for more information go here). Codensa is the story of a firm that developed a hybrid business model and jumped from being an “also-ran” utility retailer in the BoP arena, to a pioneering organization that has become a classic case study in many MBA programs.

At the customer level, access to electricity has the potential to significantly affect expenditures on other goods. The immediate benefit of electrification comes through improved lighting. Additionally, lighting promotes extended hours of study, thus leading to better educational achievement. Furthermore, electrification increases the use of electronic devices such as radio and television, which improves the access to information. Crop productivity can be increased by the application of electric irrigation pumps and businesses can be operated longer hours. As a result, electrification may also lead to higher incomes and increased expenditures in other industries. In rural Vietnam electrification among poor households jumped from 77% in 2001 to over 90% in 2008. As a result, school enrollment increased 17% for boys and 15% for girls between 2002 and 2005. Moreover electricity use has increased household’s income by 7.4%. Such positive effects last for about 9.25 years after which they peter out (Khandker, Barnes, Samad and Minh, 2009). Similar results have been found in Bangladesh as well (Khandker, Barnes and Samad, 2009).

Therefore, the question of examining BoP firms through the lenses of industries is not a theoretical one – it has very practical implications. As the case of utility retailers exemplifies, if we fail to consider firms straddling industry boundaries we become blind to the economic and social potential of hybrid business models. This is especially important in low-income markets, as the case for mobile phone banking or IT health care has shown. In other words, it means that we may not be doing as well as we could by focusing on firms from an industry perspective.

Unfortunately, if we discard the industry categorization we require something else to substitute it and this is easier said than done. Which set of categories should we use to comprehend and analyze the BoP space? Would it be more useful to take a generalist approach and concentrate on a particular region or a population segment (women, children or disadvantaged groups)? Would it be more interesting to not abandon the industry nomenclature altogether and take the middle ground by focusing on clusters or binomies of industries? These clusters could involve industries with significant potential for hybrid solution, such as finance + mobile phones or IT services + health.

Take, for instance, the myriad of social investors or foundations in the BoP arena that focus on just one or two industries. Could their impact be increased by going beyond their industry classification and analysis of BoP firms? Would social investors or foundations specializing in one industry increase their economic and social impact if they adopted an alternative approach and, if so, which one? Would business model competitions stimulate more insightful entries if they did not restrict competitors to a particular industry? Although I suspect that there may not be any satisfactory solution to these questions, by breaking through the constraints of our current industry categorization, I am hopeful that we may be in track to at least increasing the power and applicability of private sector solutions in low-income markets.