Affordability through Business Models for Distributed Energy at the Base of the Pyramid

By
Off the grid, but on the up
Affordability through Business Models for Distributed Energy at the Base of the Pyramid - Ted Ladd

Abstract

Ventures selling distributed electricity directly to impoverished consumers achieve affordability by minimizing up-front prices and collecting post-sale revenue. Through interviews with 30 practicing entrepreneurs operating at the base of the pyramid (BoP), we evaluate two pricing methods, micro-finance and pay-as-you-go, that accomplish this task. Each of these methods has implications for other aspects of the venture’s business model. With further research, these models might be adapted to other undeveloped sectors around the world that also lack infrastructure and competition.

Introduction

More than 1.6 billion people at the base of the world’s economic pyramid lack access to electricity, which undermines their opportunities for economic advancement out of poverty.[1][2] Centralized grids lack the capital and incentive to extend to remote areas, leaving the provision of energy access to entrepreneurial ventures, many of which are growing profitably.[3][4]

Many ventures set prices based on value, cost, competitors, or signals.[5] However, consumers at the base of the pyramid (BoP) have little discretionary income. Prices for products or services must therefore match the variable incomes and low cash balances of BoP customers. Specifically, they must offer products and services with a minimal up-front price that is typically below the cost of the product’s manufacture and distribution. This low up-front price is supplemented by a method to generate additional income post-purchase. Two pricing methods are gaining popularity in the BoP market for distributed energy: purchases supported by loans from micro-finance institutions and products that allow the user to pay only for the amount of energy used.

Pricing is one element within a broader business model that encapsulates the logic by which a venture creates and captures value.[6][7][8][9][10] This paper will describe the implications of these pricing choices on other elements of the venture’s business model.

Research Objectives

The primary goal of this research is to contrast the two predominant pricing strategies of ventures that have achieved affordability for distributed electricity at the BoP to understand their relative implications for the ventures’ business models and probabilities of ongoing profitability.

The second goal of this research is to discern lessons from the BoP that can be applied to other regions of the world. Markets in the BoP have several characteristics that provide additional challenges beyond those of more developed regions: insufficient or no infrastructure for distribution, low disposable income, and the absence of credit or contract law. Ventures that succeed in these extreme conditions have lessons to share with entrepreneurs in the rest of the world.

Methods

In order to capture themes from the lived experiences of practitioners, we employed grounded theory as pioneered by Glaser and Strauss.[11] [12] We conducted audio interviews with 30 entrepreneurs selling distributed electricity in the BoP between February and June 2013 using a semi-structured protocol. We asked respondents to recall the structure, mistakes, and surprises of their venture’s evolution.

Forty-three percent of the entrepreneurs operate in India, 43% in Africa, and the remaining in the Caribbean and the Far East. Forty-eight percent of the ventures are profitable and growing, 37% are generating revenues below break-even, 13% had failed, and 3% are still under conceptualization. Even though the study did not intentionally focus on renewable energy, recent reductions in the cost of renewable equipment along with volatility in petrochemical markets prompted most distributed energy entrepreneurs to employ renewable generation technologies. In our sample, 75% used solar, with the remainder employing biogas or small hydropower. To maintain respondent anonymity, no company or entrepreneur is identified by name.

We define distributed electricity as a system where the point of generation is adjacent to the point of consumption. For this study, we included micro-grids and solar lanterns. We selected this sector for two reasons. First, because it is relatively unregulated, entrepreneurs have freedom to experiment with novel models. Second, as distributed generation technologies achieve cost parity with power from centralized grids, the lessons from the BoP may apply to new ventures in more mature markets in other regions.

The interviews were transcribed and uploaded to Dedoose (v4.9) in order to discern themes within and across interviews. Specifically, we conducted three phases of coding – open, axial, and selective – as recommended by Corbin and Strauss.[13] In the first pass, we created open codes that described ideas that we noticed in multiple interviews, without regard to existing theories or conceptual models.[14] [15] This process generated approximately 30 codes across 300 excerpts. (In other words, each idea appeared in 10 different instances on average.) These excerpts were not randomly distributed across the interviews; some respondents touched on several different ideas that proved to be common across the sample, whereas others discussed experiences that were not found in other interviews.

In the second pass of axial coding, we aggregated these 30 codes into 10 categories, reflecting the larger themes that emerged from the data. We then re-read the transcripts to verify that these larger codes were justified. In this pass, we found more nuances to these themes, for which we created approximately 10 additional codes. We then identified the major findings that emerged from the data, as well as an underlying theme that connected all of them together. Our findings were cross-referenced with relevant literature to highlight areas of convergence and divergence.

To ensure that our investigation focused on understanding these areas, we created a new set of 20 selective codes based on these areas of convergence and divergence, re-read the transcripts again, and applied these codes de novo, without regard to previous passes. The final pass culminated in a code application table that illustrated the number of instances each code occurred across all of the interviews, as well as list of notable quotations to illustrate the themes found through our coding process. We caution that these results are not intended to imply statistical significance. Instead, this qualitative approach is designed to abduce new observations and frameworks from deep analysis of a limited number of anecdotes.

In total, we conducted over 22 hours of interviews with 30 respondents. We read each transcript at least five times to generate a total of 86 code tags across 657 excerpts. Six major findings emerged from the data, which we used to create a framework for business models in the BoP.[16] The following results and discussion focus on the two dominant pricing strategies employed by several ventures within the sample: micro-finance and pay-as-you-go.

Results

You cannot build poverty-destroying infrastructure by trying to sell stuff for cash.
– BoP electricity entrepreneur

Entrepreneurs selling electricity in the BoP have constructed business models that do not resemble those in developed markets. Distribution is particularly challenging in the BoP. Poor transportation infrastructure dramatically increases costs. If ventures price their products to recoup these costs, it would push them out of the reach of most BoP consumers. Several ventures have adopted alternative methods to collect revenue over a longer period of time, thereby lowering the initial price.

Micro-Finance

One method to reduce the up-front purchase price is the incorporation of micro-finance vehicles into the purchasing process (Figure 1). These types of transactions are usually facilitated by dedicated micro-finance institutions (MFIs), which often ask villagers to organize into Self Help Groups (SHGs) of consumers. These SHGs pre-select members based on their reputations for trustworthiness. With the help of the MFI, SHGs host presentations by product vendors demonstrating their wares for sale. If members of the SHG make a purchase, the MFI pays the vendor directly and collects regular payments from the purchaser that include interest and fees. The SHG is critical in that it asserts peer pressure on the purchasers to repay these loans.

Figure 1: Location and Status of Firms Employing Micro-Finance in Sample (n=9)

Micro-finance, however, still contains barriers to broad acceptance, at least in its current form. Despite the networks operated by MFIs to offer loans, they make poor distribution partners for distributed electricity enterprises. MFI field representatives visit dozens of SHGs in a day over a large geographic territory to meet with potential customers and collect payments, precluding the possibility of carrying anything but the smallest packages. Additionally, because MFIs often rotate field representatives to reduce the potential for corruption, individuals do not develop lasting social networks in specific communities.

Furthermore, some cultures view debt as a declaration of weakness. Even in those markets where debt is available and acceptable, the fundamental flaw in the MFI model is its mismatch with the existing realities facing potential consumers. Micro-loans typically require that borrowers make regular payments, even though their own incomes are highly volatile.

Pay-As-You-Go

This latter hurdle for micro-finance has opened the door to Pay-As-You-Go (PAYG) business models, which are more embedded into the habits of their customers. For example, one venture in our sample sells small solar installations to consumers at a very low cost – well below the average cost of manufacture and delivery. These products include technology that can connect to cell phones, which are prevalent in many BoP regions. The cell-phone owner then purchases “light” credits that allow the system to function for a certain number of hours. If the owner lacks disposable income to purchase more credits, the solar system ceases to operate.. If the owner has excess cash, he can purchase light credits in bulk for a cheaper cost per credit. These credits can be used over time, or resold to other villagers. Several PAYG solar products will “unlock” the system permanently once the owner has purchased a threshold number of credits, which resembles a rent-to-own model.

Figure 2: Location and Status of Firms Employing Pay-As-You-Go in Sample (n=6)

The IT systems that underlie these PAYG systems provide other benefits, in addition to their payment and processing of light credits. They can diagnose problems with solar products that are malfunctioning and assess the performance of both the initial product sales force and the resellers of light credit in order to highlight top and bottom performers.

One entrepreneur in our sample believes that his venture’s sales growth and its ability to serve impoverished populations are augmented by the PAYG model, but he laments the volatility of his venture’s revenue stream as a result of its PAYG model. Because his customers have no obligation to make regular payments, his income fluctuates seasonally as it is tied to the prices of crops that many of his customers grow. Luckily, he found patient capital investors to provide a line of credit to bridge the gap between his fluctuating income and consistent costs for inventory and overhead.

Discussion

A business model is more than a list of disparate elements to explain the profit logic of a firm. In order to create and capture value, a successful business model should be internally consistent to form a congruent whole.[17] The two pricing methods discussed in this paper are no different. Selecting one of these methods has implications for other elements within the model.

Because the micro-finance method relies on peer pressure within SHGs, it is only effective when extended to people in stable social networks. Hence, this method is ineffective for migrant populations or perhaps even rapidly growing communities that have more fluid connections.

MFIs are experiencing their own growing pains. Despite (or perhaps due to) the high demand for micro-loans, they are facing more scrutiny and regulation of their borrowing practices, including interest rate caps and fees. Several entrepreneurs within our sample are looking beyond these regulations to the long-term economic health of their potential customers by requiring a “market linkage” between the use of their product and realized economic output from increased productivity. For example, one entrepreneur in our study received a request for the purchase of a power plant from a village of weavers, who sought to employ electric looms to increase output. Even though the village had secured financing, the entrepreneur recognized that their local market was already saturated with cloth, and that the cost to transport the additional output to a distant market would overwhelm the potential profits. He refused to make the sale for fear of pushing the village into perpetual indebtedness.

PAYG methods also have implications for other elements in the business model. As mentioned previously, with fluctuating revenue streams but inflexible cost structures, they require tailored financing mechanisms – patient capital or inexpensive lines of credit.

Ventures using the PAYG method sell credits through cell phones. The relationship between the PAYG venture and a cellular carrier can be symbiotic. The functioning cell phone allows the user to purchase credits to keep the distributed energy system operating, which can then charge the cell phone. However, this feedback loop exposes the venture to another risk: if the cell phone ceases to operate, the electricity revenues will suffer.

Both pricing methods share some implications for their business models. Because they are not as straightforward as a simple cash purchase, and because the products rely on sophisticated equipment, salespeople and installers require specialized training. To accomplish this at minimal additional expense, some ventures have partnered with local schools, which add an extra degree of complexity to venture operations.

When ventures using either one of these pricing methods are successful in a particular region, their customers purchase electricity-consuming appliances, and thus have increasing incentive to use – and pay for – more electricity. This installed, stable demand entices two new types of competition. First, the operators of the centralized grid perceive a ready market for cheaper electricity, and may contemplate a grid extension. Entrepreneurs within our sample countered this potential threat by formulaically donating excess profits to local economic development. Members of the community therefore demanded that the newly arrived central grid operator purchase the otherwise stranded output from the venture and maintain the economic development fund.

A second source of competition is from government politicians, who see the popularity and impact of the electricity from these ventures and subsequently adopt policies to give away similar distributed electricity products, thereby destroying the market. One of our respondents anticipated government interference and borrowed start-up funds from a national bank – even though foreign banks were more familiar with the technology and its risks – so that national bankers would have an incentive to apply pressure on politicians to steer clear of market-destroying initiatives.

Besides the obvious requirements that micro-finance models rely on the existence of established MFIs and PAYG models rely on the broad penetration of cell phones, there is insufficient data to draw statistically generalizable conclusions from our data set to compare these two models. The relative success of ventures using micro-finance, especially in India, may be a figment of the sample, a consequence of culture or infrastructure, or a reflection of PAYG’s youth.

The distributed energy sector in the BoP has three characteristics that create boundary conditions for applying methods of attaining affordability more widely. First, despite attention from entrepreneurs, investors, and international organizations on this sector, there is still very little intra-market competition. One entrepreneur estimated that only 3% of the addressable market has been approached with distributed energy products. As a result, firms in this sector do not (yet) face competitive pressures on pricing. Second, as mentioned above, there is very little infrastructure within the BoP, including mass communications. Consumers do not have easy access to reference pricing, and thus cannot easily compare or validate substitutes or lifetime product value. Third, even though they lack access to electricity, most BoP consumers already demonstrate a demand for it.

In conclusion, ventures have two options for generating recurring revenues in order to reduce the initial up-front price of offering distributed electricity within the BoP: small loans offered through micro-finance institutions and pay-as-you-go plans. With further research, these methods might be compared to each other directly and applied to other products for sale at the BoP, as well products offered in competitive sectors in mature markets. These methods have their advantages and challenges for both the consumers and the venture’s business model, and thus must be explored in conjunction with their implications for other aspects of the venture’s operations and strategy.

Notes & References

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  3. Hart, Stuart, and C.K Prahalad. “The Fortune at the Bottom of the Pyramid.” Strategy + Business, 26 (2002), 54-67
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  6. Chesbrough, Henry, and Richard S. Rosenbloom. “The role of the business model in capturing value from innovation: evidence from Xerox Corporation's technology spinoff companies.” Industrial and corporate change, 11 (2002): 529-555.
  7. Ladd, Ted. “Business Models at the Bottom of the Pyramid: Leveraging Context in Undeveloped Markets. Mimeo Case Western Reserve University Doctorate of Management Archives (2014).
  8. Osterwalder, Alexander, and Yves Pigneur. Business model generation: a handbook for visionaries, game changers, and challengers. Hoboken, NJ: Wiley, 2010.
  9. Zott, Christoph, and Raphael Amit. “Business model design: an activity system perspective.” Long range planning 43 (2010): 216-226.
  10. Zott, Christoph, Raphael Amit, and Lorenzo Massa. “The business model: Recent developments and future research.” Journal of management 37 (2011): 1019-1042.
  11. Creswell, John W. Research design: Qualitative, quantitative, and mixed methods approaches. London: Sage Publications, Incorporated, 2008.
  12. Glaser, Barney, and Anselm Strauss. The Discovery of Grounded Theory: Strategies for Qualitative Research. Piscataway, New Jersey: Transaction Publishers, 1967.
  13. Corbin, Juliet M., and Anselm Strauss. “Grounded theory research: Procedures, canons, and evaluative criteria.” Qualitative sociology, 13 (1990): 3-21.
  14. Charmaz, Kathy. Constructing grounded theory: A practical guide through qualitative analysis. London: Pine Forge Press, 2006.
  15. Saldaña, Johnny. The coding manual for qualitative researchers. London: Sage, 2012.
  16. Ladd, Ted. “Business Models at the Bottom of the Pyramid: Leveraging Context in Undeveloped Markets. Mimeo Case Western Reserve University Doctorate of Management Archives (2014).
  17. Osterwalder, Alexander, Yves Pigneur, and Christopher L. Tucci. “Clarifying business models: Origins, present, and future of the concept.” Communications of the association for Information Systems, 16 (2005): 1-25.
Ted Ladd is a Fowler Fellow and doctoral candidate in the Department of Design & Innovation at Case Western Reserve University in Cleveland, OH. He is also a Professor of social entrepreneurship at the Hult International Business School in San Francisco, CA and a visiting professor at the Copenhagen Business School. He holds a joint MA from SAIS (with a year in Bologna in 1996) and MBA from Wharton and a BA from Cornell. Before returning full-time to academia, he spent 15 years in ventured-back mobile technology companies. He was the VP of Business Development for HOMER Energy, which provides software to over 100,000 people in 193 countries around the world designing hybrid power systems for micro-grids in remote locations. Most recently, he was the director of ecosystems for WIMM Labs, which pioneered wearable consumer electronics (i.e. a “smartwatch”) until its acquisition by Google to create the Android Wear platform. He and his wife, Laura, live in Jackson Hole, Wyoming. Contact him at ted@tedladd.com