Corporate Social Responsibility and Development
MHCi MONTHLY FEATURE:
The Fortune to be gained by CSR: Part I
MHCi started looking at the role of CSR in the social and economic development of developing countries in 2005. This article is based upon a chapter in the author’s book on the subject. – CSR and International Development (2007). This first feature first looks at Prahalad’s celebrated work on the Fortune at the Bottom of the Pyramid. Briefly, cure the feature finds Prahalad’s ideas wanting. The author then wonders whether the notion of CSR could be a better concept in which to engage corporations in economic development, click this is looked at in Part II. Parts II-IV are to come, thumb with Part IV having had to wait until September 2010!!
But, first, the late Prahalad’s influential ideas.
Prahalad, in his celebrated book, The fortune at the bottom of the pyramid, rightly noticed that of the world’s 6.5 billion people around 4 billion of them live on less than $US1500 per capita per year (real purchasing power parity values). His pyramid has 75-100million in the top portion earning more than $US20,000 a year, then 1.5 to 1.75billion earning between $1500 and $20,000 a year and the poor 4 billion earning less than $US1500 a year. With the majority of potential consumers being poor, Prahalad’s argument is that an ignored source of market promise are the billions of poor who are joining the market economy for the first time.
His argument is consistent with CSR in that by doing good to its consumers, in this case billions of consumers, TNCs can increase their profits – the prospective rewards he says include ‘growth, profits, and incalculable contributions to humankind’. The key to unlocking this potential is for TNCs to use technology to produce affordable products for the poor. One example he gives is the case of Hindustan Lever Ltd (HLL), a subsidiary of British Unilever PLC, who has been a pioneer in exploring markets at the bottom of the pyramid. It was slow to enter the market and it was only when a local firm Nirma Ltd began, in 1995, offering detergent products for poor consumers, mostly in rural areas, that Unilever took notice. Nirma grew rapidly and HLL saw that its local competitor was winning in a market it had disregarded. HLL came up with a new detergent called Wheel, formulated to substantially reduce the ratio of oil to water in the product, responding to the fact that the poor often wash their clothes in rivers and other public water systems. HLL decentralised the production, marketing, and distribution of the product to leverage the abundant labour poor in rural India, quickly creating sales channels through the thousands of small outlets where people at the bottom of the pyramid shop. HLL also changed the cost structure of its detergent business so it could introduce Wheel at a low price. HLL then registered a 20% growth in revenues per year between 1995 and 2000 and its market capitalisation grew to $US12bn. Unilever has benefited from its subsidiary’s experience in India to create a new detergent market in Brazil.
There are other opportunities too. These are not necessarily low tec since there are other ways in satisfying basic needs. Communication is a basic need, but half of the poor have never made a telephone call. Costs are high too. For someone in the USA to call his/her banker in Switzerland can cost as low as 1cent a minute, or even be ‘free’ if VOIP (Voice over internet protocol) is used. Yet, someone trying to sell gum in Somalia to a developed country market would pay at least a dollar a minute – one hundred times more! Part of this is institutionally driven since many developing countries see telecommunications to be the preserve of the rich and therefore an alternative form of taxation. It also has to be admitted that individuals in many developing Governments benefit hugely from either a direct, or an indirect, association, with a telecommunication company.
Problems with the concept
There are clearly many benefits for a TNC to develop their business at the bottom of the pyramid. Prahalad undoubtedly identifies that there is wealth that can both be tapped and generated, there. But there is also much wealth at the middle and the top of the pyramid and even easier to get at.
Remember from above that Prahalad’s pyramid has 75-100 million in the top portion earning more than $US20,000 a year, then 1.5 to 1.75 billion in the middle portion earning between $1500 and $20,000 a year and then 4 billion poor earning less than $US1500 a year. For purposes of calculation, I shall use 100 million people earning on average $US50,000 a year, 1.75bn people earning $US10,750 a year and 4 billion people earning $US750 per year.
Thus using Prahalad’s own data, with my modified mid-point income, shows that the third, poorest, tier contains 68% of the world’s population but only 11% of its income. The richest tier or 2% of the world’s population have 19% of the worlds’ income and the middle tier or 30% of the world’s population have 70% of its income. Even if I assume that the poorest tier earn as much as $US1500 a year (the top of the interval scale chosen by Prahalad) the figures do not change that much. The poorest tier then have 20% of the world’s income, the richest tier 17% and the middle tier 63% of the world’s income!
Hence it is not altogether surprising that the world’s largest companies go where the income is being earned i.e. in the richest and middle tiers where there is a higher concentration of richer people! Obviously, transaction costs are less to reach middle income consumers in the richer parts of the world – why sell mobile phones across the vast Sahara desert when the sprawling metropoli of Tokyo, Milan or Beijing have a host of willing consumers? Prahalad’s economics look faulty even using his own data!
Now I do not want to weaken Prahalad’s argument and therefore convince the rich companies to ignore the bottom of the pyramid – particularly the necessary research, development and ‘management’ technology that Prahalad’s ideas will bring – far from it as will be seen below. But poor argumentation will not help the world’s poor and there are at least four further problems with Prahalad’s argument.
First, and an old chestnut in business circles, is that if business can make huge profits at the bottom of the pyramid, why don’t they do that anyway? To a certain extent they have been what they can to make money for years. I remember travelling in Somalia in the mid 1970s (when the country had a functioning Government under Siad Barre) a half a day north of the capital in a 4×4 (needed, unlike the ridiculous trend for SUVs in developed countries with their excellent roads) since roads petered out half away along the route. Then we walked for an hour, then took a boat across a river and were then met by the heads of a village of about 1500 people. For their visitors, and we were numerous, everyone was served with Fanta! The Coca Cola Corporation had been there ahead of us! So, if there is a fortune at the bottom of the pyramid, why haven’t the TNCs been there already? Certainly, part of it can be explained by the fact that many have not thought of the possibilities. But the costs of supplying goods and services to people without an awful lot of purchasing power, are enormous. Prahalad does realise that building a complex commercial infrastructure for the bottom of the pyramid is a resource- and management-intensive task. ‘Developing environmentally sustainable products and services requires significant research. Distribution channels and communication networks are expensive to develop and sustain.’ Yet he also notes that ‘few local entrepreneurs have the managerial or technological resources to create this infrastructure’. TNCs can then help by transferring knowledge from one market to another, and can act as nodes for building the commercial infrastructure and providing access to knowledge, managerial imagination, and financial resources. But why would TNCs do all this when it is easier to focus on where the money is at the top and middle of the pyramid?
Prahalad does not answer this but the CSR approach does give us, perhaps, a more complete answer. Now, today, the 4 billion poor have little to offer TNCs but as their purchasing power takes off they will become a bigger and bigger market for TNCs. It is part of the CSR argument (as I have argued in my book The Planetary Bargain: CSR Matters) that through focusing more on their stakeholders that TNCs will see that it is in their own interest to promote development. This will be argued in Part II. But the weakness in Prahalad’s argument is that his approach is essentially one of ‘count, cost and supply’ or what economists call a supply side approach.
This is the second problem with Prahalad’s approach, he essentially ignores the demand side or how poor people will actually be able to earn income. His main argument for stimulating the demand side is to turn the poor into small scale entrepreneurs and, to do this, Prahalad places his eggs mainly in the micro-credit basket. There is an enormous literature on this topic and, on balance, the literature demonstrates the success of such schemes.
This is because, one of the key problems of under-development is the lack of access to credit at a reasonable real interest rate. This gap has started to be closed through such innovative schemes as micro-credit schemes pioneered by Mohamed Yunus and his Grameen Bank. Briefly, small groups of savers (largely women as these have been shown to be more careful than men) contribute as little as $US1 a week. Loans are then made to members of the group for as little as $US25 to purchase such items as chicken wire to keep chickens from running all over the place and gathering disease. Peer pressure is placed on the borrower to repay the loan according to a pre-determined schedule. Claims of up to 99% repayment have been achieved and monies then used to develop the wealth of the local communities. Nevertheless, real interest rates of the order of 33% a year are thought to be the minimum to ensure the viability of such funds.
There are two problems with the approach, first it assumes that there is sufficient income within the local community to buy the products produced, two it assumes that the business plan submitted and accepted is viable and yet often the community has no real experience of running small businesses. But, a major problem has been the problem of success. Once the small micro-credit scheme starts to take off and larger and larger loans are required, links with more formal banks are required. But banks have been reluctant to loan at the bottom of the pyramid for the simple reason that they make enough money higher up the period where costs of lending are lower, and the recipients more sophisticated. Of course, the actual cost of setting up a large loan is lower than that of a small loan. The small micro-credit groups succeed because many of their costs are covered through the voluntary contribution of time by the members of the fund. In a larger institution these costs have to be turned into real cash.
There is no magic formula for creating income (what economist call effective demand) for poor people. Most new employment in developing countries comes through small and medium sized businesses (SMEs). Of course, an SME needs a market and is greatly helped if it has links into a larger company. Consequently, efforts by large companies such as TNCs to improve the performance of their suppliers has all round benefits. This is discussed later, but it is worth pointing out that supplier codes of conduct, although created with the best will in the world, can have the negative effect of making it very difficult for small companies to comply and, therefore, supply.
A third problem with Prahalad’s approach is that he, like many others, have preached the virtue of technology as a tremendous help to those at the bottom of the pyramid. However, a walk around any poor area in the world will show that technological fixes are far and few between. Nevertheless, technology can help in may areas – robust seeds (note the tremendous positive effect of new hybrids of rice that provoked the ‘green revolution’ in the 1960s and 70s), cheaper telecommunications, more robust products (such as wind up radios), rehydration salts to cure diarrhoea a major killer of babies, improved technology in governance systems and security as well as management techniques themselves.
Fourth, Prahalad, in his book, rightly identifies a key problem as the one to create the capacity to consume but then identifies only a partial wrong solution. He notes that the traditional approach to creating the capacity to consume among the poor has been to provide the product or service free of charge. Rightly dismissing this since philanthropy might feel good but it ‘rarely solves the problem in a scalable and sustainable fashion’. For a discourse on CSR and charity, where I argue that the two are not synonymous, see www.mhcinternational.com/mf.htm. Interestingly, Prahalad suggests meeting consumer demand of the poor through packaging items in smaller quantities! Because the poor have unpredictable income streams they are forced to make many trips to a store because they simply don’t have sufficient cash in their hand to mouth existence and must therefore buy, for instance, one aspirin rather than buy a whole bottle at once. Yet, such a strategy will tend to keep the poor poor simply because their transaction costs will be higher than richer folk – not only in additional transport time since they will have to travel more frequently and shops are not always well positioned for the poor especially the women who have to shoulder the burden – higher but also they cannot benefit from the economies of scale that larger amounts offer the richer consumer.
So, is there a way out of this trap, what has been called in the past the poverty trap? Yes, and much can be gained for the poor through the notion of corporate social responsibility which, as I shall argue in Part II (available next month), may provide a revolutionary basis for the way in which the main problems of world poverty and under-development can be tackled. And, this can be done through convincing players large, medium and small that there is a fortune to be gained by CSR.