13 July 2012 ~ 1 Comment

The emerging market problem: should we aim for higher profit margins or better business strategies?

The post below is a comment written in response to a Harvard Business Review article “Businesses Serving the Poor Need to Get Over Their Unease About Profit” by Erik Simanis. The article uses examples of products designed for high-volumes low-margin sales strategies which failed and counters that with micro-finance as an example of high margin BoP offerings, coming up with the conclusion that we need to aim for higher margins in our emerging market business models. While I agree with aspects of the premise of his argument, I don’t agree with how he has set out to prove it or the examples he has used, hence, my thoughts below:

I’m afraid I can’t agree with the logic used in your cause and effect analysis, and I think it’s unfortunate that the same examples continue to be used to highlight “price/positioning” failures, when they are often “management decisions making/design/business offering” failures.

To be clear, I agree with you that we need to “get over the unease about profit” when it comes to emerging markets – the lessons I learned during six years in Cambodia highlighted to me that sustainable long-term solutions to many of the problems we see in the world are not going to come from aid organizations giving things away or companies selling inferior products at a loss. I agree with you that many of the solutions will come through business, and using smart business practices. But I disagree that the differentiator of success is target profit margin, and I disagree that high profit margin goals in the micro-finance sector has led to a higher net impact for people living in emerging markets. Yes, it has led to higher investment potential, but like many situations attracting a high volume of investors, it is also leading us into higher bubble-bursting potential.

From my perspective, Pur did not fail because they tried to price a product too low. They failed because they offered a product people aren’t intrinsically interested in using making the cost to educate people on their product perhaps too high, and the fact that their competition is a more sustainable option (ie. an in-home water filter costing a few dollars which lasts for a few years vs having to buy 10 cent packets every day to clean your water).

Have you seen Pur work? When I was at one of their demonstrations, I was mesmerized by the “magic” of it all, but certainly was not interested in drinking the water. It’s not the only product of its kind. There is a natural salty rock-like substance that does a similar thing, has been around longer, and has equally failed to be adopted by large numbers of people looking to clean their water. The people I know who were using it 5+ years ago in Cambodia were all foreigners or foreign educated Cambodians trying to “teach poor people” to use the product, like P&G was trying to do. The thing is, “the poor people” are still PEOPLE, and many people, like me, when they see the product, want nothing to do with putting some powder or rock into their water and then drink it. So to achieve sales, they not only had to offer a product at a competitive price, but they had to educate consumers about why it was safe, etc – and I assume many people tried it once for the fun factor but then realized they’d need to purchase it every day, worked out the math, and decided it wasn’t worth the money.

The product was designed to be a low margin, high volume product that P&G could sell to increase their reach across the BoP but was clearly not designed based on user input towards solving a complex problem. I argue that if they had taken the latter route, they would have found a different and more sustainable product that added greater benefit and then would have been able to make money off of the solution – but then again the ideal water filtration product would not fit into P&G’s FMCG model. So they offered something that was less than ideal, and they failed, just like thousands of other businesses that offer products that fail to meet consumer needs.

And the same goes for the snack food. There are other snack foods that DO reach every corner of specific BoP markets. Why? Because people want them, they taste good, the health benefits are well understood, or they are a known brand, etc. The same reason snack foods reach every corner of the “developed” world. Do we lament the thousands of snack foods that must fail each year in the USA as they seek to generate enough demand or income? If the manufacturer got their business plan wrong: in terms of pricing, break even, or in many cases, product offering or branding, then they fall into the same fate. Most new businesses fail. It’s not any different if we are trying to pat ourselves on the back for doing good for “poor” people than if we are trying to exploit the lack of will power of Twinkies eating Americans.

To highlight your argument, you use micro-finance as your “good” case, using what, in my opinion, is the entirely incorrect measurement of success.  The growth is the micro-finance sector has been donor/investor/speculator driven. There had been so much money going into this space, with investors and NGOs crawling over each other to start yet another MFI, and you act as if investment interest is a measurement of business model success, or an even further stretch, as if investment interest equates to high impact on the ground for BoP borrowers.  Were you just as keen on the growth of the mortgage sector when investors were tripping over themselves in the housing debt market? We all know how that turned out.

During the time I lived in Cambodia, I watched the number of micro-finance institutions in the area where we worked grow from 1 to 8, with many reporting to their investors or donors, as the case may be, their 95% or higher repayment rates. The thing is, without legitimate credit bureaus, they have many of the same borrowers, who borrow from one, then the next, then the next bank until they end up with the same loan shark who was there before these world-saving institutions showed up, only now they owe more than they ever would have without the MFIs. And yet, we call this progress and this is the model you want us to copy?

I was on a panel last year with the founder of Compartamos, the Mexican MFI which had an IPO highlighted above, and he talked about many of the practices that made their business successful, such as investing in staff training, etc. I am sure he too would agree that good business practices can not be boiled down to high profit margins, and that other MFIs with similar profit margin targets have failed to meet their business or social impact measurements, not because they didn’t aim to make enough profit, but instead because they aimed to make too much but forgot that running a good business takes a lot more than a good financial model.

Micro-finance CAN be great business: for the investors and for the world. So can water purifications systems. So can highly nutritious snack foods. And some of each of these will fail or succeed. The “moral of the story IS clear” I believe, but I don’t draw the same conclusions you do. Like in all business around the world cracking profitability requires not only thinking about the financial plan, but also making sure your product fills consumer needs and is demanded. The MFIs, the snack foods, and the water systems – just like the banks, the Smart Water, and the Twinkies – which are most successful from the consumers eyes and which will continue to sustain demand in the future, are the ones that are actually taking the user’s needs and desires into account. They are including consumer input in their design process, are providing something which doesn’t seem like “magic” but is instead understood as a real solution to people’s needs, and for those gaining accesses to lower interest capital due to their “social impact mission”, they should also be tracking their impact financially as well as socially.

As with all business, the proper profit margins will be different for each company, based on their overhead costs, riskiness, cost of capital, competition, social impact goals, etc.  I think it misconstrues the argument to highlight companies that failed to innovate and build trust & demand in emerging markets as if doing so in our “emerged” ones would have led to different results.  If we fail to highlight that good business practices overall are essential for success in emerging markets we’re continuing to promote failures based on sympathetic and uninformed business models where people walk away stamping their feet that “they tried to help the poor and the poor didn’t want it.” What we need is empathy – the ability to put ourselves in someone else’s shoes, and co-create a solution that people will demand and pay for. That’s good business, no matter where you are in the world.

If you want to read the HBR article, click here.

  • Andy Gray

    If Mikey doesn’t like it…