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Lessons for Multi National Corporations from Markets at the Bottom of the Pyramid

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In this excerpt from his book, C.K. Prahalad explains that the choices at the Bottom of the Pyramid are simple: either change your management systems to cut costs or lose significant amounts of money.
This chapter is from the book

The most interesting lesson for MNCs from operating in the BOP market is about costs—for innovation, distribution, manufacturing, and general “costs of organization.” Because the BOP forces an extraordinary emphasis on price performance, firms must focus on all elements of cost. Shortage and the cost of capital force firms in BOP markets to be very focused on the efficiency of capital use. MNCs tend to impose their management systems and practices on BOP markets and find that it is hard to make a profit. The choices are simple: Change the management systems to cut costs or lose significant amounts of money. The lessons learned from BOP markets by MNCs are covered in the following sections.

Capital Intensity

The judicious use of capital is a critical element of success in BOP markets. For example, HLL works with negative working capital. It focuses on reducing capital intensity in plants and equipment. By focusing on a judicious mix of outsourcing to dedicated suppliers, it not only reduces its capital intensity but also creates several small- and medium-size enterprises that can conform to the norms and standards set by HLL. HLL, as the only customer to these suppliers, can and does influence their operations. Second, a senior management focus on logistics and distribution is critical for reducing the capital needs of the business. HLL serves 850,000 retail outlets in one of the most difficult distribution terrains. The sales data from every retail outlet is collected and processed in a central processing facility. All the retail outlets are serviced frequently. Finally, a focus on revenue management allows for reducing the capital tied up in receivables. HLL can collect revenues in real time as the goods leave the warehouses of their suppliers. The suppliers might provide credit to the dealers and retailers. HLL as a manufacturer can reduce its capital intensity. The results can be compelling. For example, the system for focusing on capital first initiated with the introduction of the detergent Wheel to the BOP provided evidence of how many more opportunities for value creation can be unearthed by serving the needs of the BOP. A comparison of the financial performance of Nirma (the local competitor), HLL in the top of the pyramid market with Surf, and HLL in the BOP market with Wheel is shown in Table 3.1.

Table 3.1  Economic Value Creation at the BOP


Nirma

HLL (Wheel)

HLL (Surf)

Sales ($ Million)

150

100

180

Gross margin (%)

18

18

25

Return on capital employed (%)

121

93

22

Notes: The bottom line can be very profitable. Low margins/high unit sales. Game is about volume and capital efficiency. Economic profit versus gross margins.

Source: John Ripley, senior vice president, Unilever PLC.

It is important to separate gross margins from return on capital employed (ROCE). The real economic profit is in the effective use of capital.

A similar situation exists at the Aravind Eye Hospital. It uses the most modern equipment available in any facility in the world. Its costs are dramatically brought down by its capability to use the equipment effectively, as it specializes only in eye care, and every doctor and nurse team performs an average of 50 surgeries per day. Only 40 percent of its patients pay. A cataract surgery costs $50 compared to $3,000 to $3,500 in the United States. In spite of these differences, Aravind’s ROCE is in the 120 to 130 percent range. Aravind is totally free of debt. The revenues for the year 2001–2002 were Rs. 388.0 million ($86 million) with a surplus (before depreciation) of Rs. 210.5 million ($46.5 million). This would be the envy of every hospital in the United States. The productivity and the volumes at Aravind are the basis for this level of profitability. Every doctor accounts for 2,000 operations per year, compared to a national average of 300 in India. The four locations in the Aravind system process more than 1.4 million patients (including 1,500 eye camps) and perform 200,000 surgeries. They operate with about 80 doctors and a total staff, including paramedics, counselors, and others, of 1,275.

With an ITC e-Choupal, it costs the company about Rs. 100,000 ($2,100) per kiosk installation. The company saves about Rs. 270 per ton on the acquisition of soybeans. The payback period can be as low as one full season. The recovery of that investment requires an acquisition target of about 4,000 to 5,000 tons from a single kiosk. (A cluster of villages is supported by the kiosk.) Adding additional services such as selling seeds, fertilizers, and crop insurance can enhance the profitability of the system. The economic returns can be significant.

Sustainable Development

BOP markets are a great source for experimentation in sustainable development. First, resources such as water, energy, and transportation are scarce and expensive. Automotive and two-wheeler manufacturers are learning that the BOP customers are attuned to the total cost of ownership and not just the cost of purchase. The miles per gallon—the efficiency of energy use—is a significant determinant of market success. Similar demands are imposed on water use.

BOP markets can also represent an emerging problem. Single-serve packaging is advantageous to create the capacity to consume at the BOP but can also lead to a major environmental problem. More than 13 billion single-serve packages are sold annually in India, and this trend is growing rapidly. Although plastic bags appear attractive, they are not biodegradable. MNCs involved in the BOP markets have the capability and the motivation to find solutions to the problem of packaging in emerging markets.

Innovations

As we discussed in depth in Chapter 2, the process of innovation for the BOP forces a new set of disciplines. First, the focus is on price performance. Innovations must become value-oriented from the consumer’s perspective. The BOP focuses attention on both the objective and subjective performances of the product or service. Markets at the BOP also focus on the need for 30 to 100 times improvements in price performance. Even if the need is only for 10 to 20 times improvement, the challenge is formidable. The BOP can become a major source of innovations. Consider, for example, the need for user-friendly interfaces. Biometric authentication systems such as fingerprint and voice recognition are emerging from the BOP markets, as we saw in the case of PRODEM FFP in Bolivia and Elektra in Mexico. Logistics and distribution requirements are an integral part of the innovation process at the BOP.

Serving the BOP forces a new business model on MNCs. Management systems developed for a price performance level cannot be fine-tuned to cope with the demands of the BOP markets. Although MNCs are slowly adapting to the needs of the BOP, few have consciously focused attention on examining the implications of their own operations in the BOP for their global operations. So far the attention has been on outsourcing from the more cost-efficient locations such as China, Taiwan, Thailand, the Philippines, and India. A $50 CD player is not just about wage rates, but a totally different way of approaching manufacturing.

The I curve has different implications for scaling. The timing of investments, investment intensity, and the pace of market and distribution development become crucial, as is the rate at which costs must be brought down to fuel growth of the market.


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