October 22, 2019

Five questions every social business must ask

Businesses have the capacity to address poverty at scale, but very few succeed. To change this, investors and practitioners should note four common challenges and ask five simple questions.

7 min read

Market-based solutions (MBSs) are viable businesses that straddle the worlds of commerce and development by providing affordable, socially beneficial products and services to people with limited resources. Unfettered by subsidies, they have the potential to help tens—if not hundreds—of millions of lower-income households around the world.

Over the past 12 years in India, I have worked on MBSs targeting base of the pyramid (BoP) customers, looking at more than 800 businesses and digging deep at an operational level into housing finance, drinking water, early education, and sanitation. Again and again, I’ve seen organisations fail at market-based solutions for four main reasons:

  1. They lack robust and innovative business models.
  2. They fail to test and refine their business models.
  3. They overlook ecosystem barriers.
  4. They use inexperienced business leaders.

Related article: Market forces can be powerful in driving social change

This is not an easy space to work in, but it is time for those of us who believe in the potential of markets to double down and make them work. Imagine if we could harness MBSs to improve education for low-income families or to help lower-income urban residents escape the cycles of rent and buy their own homes. Here are some waypoints on the journey to better MBSs:

1. Build innovative and robust business models

If a straightforward tweak of an existing product or service can serve the BoP, India’s vibrant marketplace will find a way to provide it. For example, companies recognise that people at the BoP have limited funds, so they sell products—such as shampoo, instant coffee, candy, superglue, detergent, and insect repellant—in small packs that cost a few cents.

But it’s impossible to package everything this way. Quality schooling or heart surgeries don’t fit in a little bag, and improving services like them requires more complex and innovative business models, a number of which are described in our 2009 report.

Take getting a loan. Banks’ traditional process asks borrowers to come into an office with documentation verifying a stable source of income or sellable asset. Microfinance takes an innovative approach: the underlying security is not a stable source of funds or an asset, but collateralisation by a group. This requires a completely different service model; a field officer travels to where the borrower lives and from there conducts all the business of microfinance: forming groups made up of local residents, disbursing loans, and holding regular meetings to collect payments.

But having an innovative solution isn’t enough. Organisations also need a solid value proposition. I have seen numerous products appear as if they should be valued by a customer, but in the context of the BoP, they are not. A rental company discovered this when it tried to provide migrant workers higher-quality living quarters for slightly more than the price of the cheaper and cramped spaces that the workers usually rented. The workers were okay with the less spacious and less expensive option because it allowed them to save money for other purchases, such as a smart phone.

Housing in Shillong Meghalaya Dhruvank Vaidya

The value proposition, the details of distribution, and the economics of profitability are all important aspects of an innovative business model, but they’re not everything. | Picture courtesy: Dhruvank Vaidya

Then there are the practicalities of distribution. BoP entrepreneurs in a village may want to sell products like cook stoves to other rural residents, but how do they carry such heavy objects the long distances required to reach enough villages to get the customers they need to earn a decent income?

Innovators must also understand the full cost of their product or service and how that balances against profits. An agricultural products firm working across India had a more effective approach to pest control using pheromones. But this required both convincing farmers about the effectiveness of the approach and educating them on how to use it.  Adding in these extra costs made the profitability much lower than expected.

The value proposition, the details of distribution, and the economics of profitability are all important aspects of an innovative business model, but they’re not everything. Firms pursuing success also need to consider many other factors, a few of which include the size of the market, marketing, sales, and inventory management. Thinking through as many elements as possible can help ensure an innovative business model is commercially viable and operable.

2. Invest in sizeable pilots to refine and evolve the business model

In 2011, I was one of three researchers who examined 30 of the best companies in the portfolio of Acumen, a global fund begun in 2001 to invest “in entrepreneurs bringing sustainable solutions to big problems of poverty.” It became clear that having an innovative business model was not enough. The model had to go through a process of piloting, tweaking, and even complete redefinition before it began to work. As every thoughtful impact investing funder knows, this takes significant effort, resources, and time, typically at least five years. But many funders with less experience in MBSs fail to recognise these facts and possess unrealistic expectations.

In addition to coming up with an innovative business model, organisations face challenges in the environment in which they operate.

Husk Power Systems, a renewable energy provider working with rural communities, offers a good example. The company undertook systematic piloting with financial support and thought partnership from Shell Foundation. Husk’s initial two plants demonstrated that it was possible to generate gas from rice husks and use the gas to generate electricity at an affordable price. And it took significant tweaking of the initial design to achieve this. Husk also worked to reduce the amount of tar produced by the process by 20 percent. The company went on to build three more plants to demonstrate that they could quickly scale up while managing costs and maintaining performance. Husk also developed and piloted a pre-paid meter system to address the challenges around collecting payments from rural customers. The result? The company attracted investment and set up 75 plants in five years.

3. Understand, address, and leverage ecosystem barriers

In addition to coming up with an innovative business model and validating it, organisations often still face challenges in the broader environment in which they operate. In the work we did at Monitor Inclusive Markets from 2006 to 2013 to facilitate low-cost home ownership, we discovered three types of ecosystem barriers:

Value chains
Even if we got developers to build low-cost homes, how would customers buy them? There was no financing available to our customers, who typically worked in the informal sector, meaning they were self-employed or small-scale entrepreneurs such as tea stall owners. Banks and other lenders were focused on customers with documented incomes, something most of our informal-sector, would-be homeowners lacked. We developed a business model that used field visits to produce proxy measures for determining people’s incomes. We used this model to launch two housing finance companies, an approach copied by others.

Public goods
If a new idea fails, the originator bears all the costs, and if it succeeds, it becomes a public good that other firms use. We often found this pattern in our housing work. For example, we learned that while most real estate developers agreed there was need for affordable 300-square-foot apartments, they were unsure about the speed of sales, which was critical because the underlying business model had lower margins but quick turnover. After interacting with more than 600 developers, we found one to work with in Ahmedabad. We helped him locate land that was affordable and attractive to customers, develop architectural plans, and price the offerings so they would be sold quickly and profitably. We also helped him find customers through our network of CEOs, who let us sit in their factories’ cafeterias during lunch and sign up workers for the homes.

Related article: Where do the disruptors go?

The 450-home project sold out on the first day and had a waiting list of 9,000 people. Seeing the success, other developers in Ahmedabad soon started low-income projects, and the technology entrepreneur Jerry Rao started a company to create such housing nationally. Our housing work also showed that customers would only buy homes in projects that were near schools and had convenient transportation to their workplace. How was a developer supposed to provide public goods like schools or transportation options?

Regulations may inhibit innovative new models. Bangalore City, for example, required every new housing project to include space for car parking, yet low-income customers own motorbikes. We started working with the national Ministry of Housing and Urban Poverty Alleviation on policies that would be the norm across all states in India, and we also worked with the state of Odisha on applying these policies at the local level.

In January 2013, seven years after we started and five years longer than we planned, 78,000 houses had been sold and 10 housing finance companies were active with a loan portfolio of more than $200 million. This success and the challenges we encountered on our journey inspired further research on ecosystem barriers, which pointed to the importance of having a facilitator who would address the barriers, rather than tasking every individual business with the responsibility. It echoed findings about developing MBSs from other organisations, including Omidyar Network, the United States Agency for International Development, and the Department for International Development in Britain.

4. Attract experienced business leaders

We have creative, motivated, and passionate people leading MBSs, but very few of them have experience building large-scale businesses. This is a well-recognised problem that funders have tried to address with fixes that include putting leaders through crash courses at business schools, providing business veterans as mentors or board members, or hiring experienced mid-level managers.

Socially relevant and large-scale market-based solutions need leaders who have done the work before and made mistakes.

But a month or two of courses, mentorship, or delegation can’t give leaders the skills they need to succeed, especially in complex businesses like health care, schooling, or farming that involve field operations. Nothing often works as planned. Socially relevant and large-scale MBSs need leaders who have done the work before, made mistakes, learned to bring out the best in under-resourced teams, and developed a sense for capitalising on unexpected victories.

The timing may be right to fill the skill gap—more and more corporate leaders are growing increasingly interested in social issues, but most established companies are unlikely to dive into MBSs. Perhaps more industries can become like the financial services sector in India, where a number of innovative firms providing MBSs are helmed by leaders with more than two decades of experience.

Five Questions

My observations may seem obvious, but I still see investments in organisations that haven’t addressed them. We can create more and better MBSs if organisations take the time to ask some basic questions:

  1. Why would customers buy this product or service rather than other options?
  2. Have all the costs of the business, such as educating customers about a new product or building new distribution, been accounted for?
  3. How realistic are the timelines to pilot, evolve, and validate the business model?
  4. How will the broader ecosystem—from regulations to ancillary businesses—help or hinder your efforts?
  5. Do you have an experienced leader who knows how to respond to adversity, take advantage of opportunities, and run businesses in an unpredictable environment with limited resources?

I urge investors and practitioners passionate about MBSs to ask these questions to make sure we build viable businesses that solve real social problems. We owe it to the millions of people we’re trying to help.

This was originally published on Stanford Social Innovation Review (SSIR). 

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Ashish Karamchandani

Ashish Karamchandani is a senior adviser at FSG. He is currently co-leading a programme to improve private preschool education for low-income households in urban India. He was the founder of Monitor Inclusive Markets (MIM), a social action unit within the Monitor Group. He also co-founded Ummeed, a nonprofit organisation in India that works with children with developmental disabilities. He holds a Bachelor of Technology from Indian Institute of Technology, Bombay, a Master of Science from University of California, Berkley, and a PhD from Stanford University.

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