Business models can become a key element for reducing the gap between the rich and the poor. That’s according to a new study by Juliana Mutis and Joan Enric Ricart, two researchers at the IESE Business School, published in a recent issue of Universia-Business Review. The study is titled, “Innovation in Business Models: The Base of the Pyramid as a Realm for Experimentation.”
Mutis explains that working at the bottom of the pyramid provides companies with new possibilities to not only penetrate new markets — thus, contributing to the reduction of poverty — but also with new lessons and skills for competing on the basis of continuous innovation. “The base-of-the-pyramid model for analyzing businesses enables us to understand the dynamics of the base as well as the competitive advantages that enable companies to develop that base.”
Although they account for most of the world’s population, poor people have been prevented from participating in the global economy. That’s why low-income markets are an incomparable area for analyzing the importance of choosing the right business model, the researchers note. “Low-income markets constitute an important share of the market, an opportunity to innovate and develop new comparative advantages. International organizations such as the World Bank are forecasting that by 2050, about 85% of the world’s population will be living in developing countries, so making this kind of change in the socioeconomic pyramid means innovating,” explains Mutis.
According to the authors, “The most common strategy for multinationals in developing countries has been based on transferring the business models they use when competing in their countries of origin. In a passive way, they hope they will be promoting the growth of a middle class capable of acquiring these products and services.” However, this approach has resulted in strategic inconsistency. On the one hand, companies try to find millions of new consumers, but on the other hand, their business models are not adapted to those markets. As a result, they reach only the tiny, most affluent part of the population. That is to say, they reach only “the top of the pyramid.”
An Area for Experimentation
Mutis and Ricart advise companies to stimulate business and development at the bottom of the pyramid by undertaking responsible business activities. That means reformulating traditional management practices; understanding the competitive dynamics of this sort of market and designing business models, products and innovative strategies that can provide profitability as well as social development. They also stress the need to develop new capabilities that will enable the company to remain competitive in the future. “The company creates more strategic networks, which co-create and extract value from its allies in order to increase the impact of its products and services, and also increase their value for consumers and [the company’s] allies. Because the company becomes a catalyst for development and provides comprehensive solutions, it identifies the shortcomings of the market and offers solutions that none of its allies or even the company itself could have provided efficiently all by itself.” According to Mutis and Ricard, business models that are used in low-income markets can help companies learn and develop the new skills that keep them competitive.
The study establishes the connection between the value of reducing poverty through business activity, and the need for learning new skills for competing by using new business models as a foundation. It stresses the importance of developing new and efficient business models that can create value for everyone, enabling companies to move into areas even where the market is failing, and/or permitting them to overcome some of the vicious cycles of poverty that ensnare that population. Nevertheless, these sorts of efforts remain rare. “There is still a great deal of ignorance, and most of the initiatives are started as CSR (Corporate Social Responsibility) efforts that do not commit all of the resources of the company,” notes Mutis.
What exactly is a business model? The study defines it as “the combination of corporate choices and their consequences.” Add the authors, “Those choices can be the policies behind the way a company functions; the physical assets where it decides to invest; and the structures for governance that it creates for implementing its policies and managing its assets.” Clearly, this is about the way the company operates. The choices in any business model can have consequences because their interrelationships lead to virtuous cycles, which constitute, in turn, a characteristic and revitalizing feature of business models.
The Key to the Effectiveness
The effectiveness of any business model, especially at the base of the pyramid, depends to a great degree on its design and on the way it interacts with other organizations and people. “The added value of a business model increases to the extent that the combined resources and capabilities that surround it become more difficult to imitate; less transferable; less subject to substitution; and more complementary,” notes the study.
Business models change and adapt themselves to compete more effectively under future market conditions. Companies face growing competition stimulated by globalization and new technology, and consumers are becoming more aware and more demanding. Nowadays, it is not enough to compete on the basis of products and services that are different. So companies are forced to search for novel ways to create value for their customers. In that regard, the authors outline the characteristics of a good business model, beginning with the appropriate use of technology. Business models that target the base of the pyramid must almost always address “virgin markets” that lack the sort of infrastructure that has a prolonged period of amortization. These markets are “the ideal environment for incubating new and advanced technologies,” say the authors. On the other hand, the authors advise companies to base their business models on the efficient use of capital and the intensive use of labor, not the traditional model based on the intensive use of capital and the efficient use of labor that is effective higher up the pyramid.
The authors add that it is very important to build nontraditional relationships with local governments, small and medium enterprises, and organizations that promote civil society, rather than depend on more traditional partners such as central governments and large companies. Large companies, they note, “miss out on a lot of information about the local context and they put their adaptability and legitimacy at risk.” This new approach provides companies with more flexibility, knowledge and legitimacy for connecting at the base of the pyramid. Companies need to establish local relationships that provide the social capital required for overcoming the absence of formal institutions that protect intellectual property rights and guarantee respect for law.
When it comes to reducing costs, the authors note that producing locally is a good option because it allows companies to adapt their products to local characteristics and needs.
Challenges and Opportunities
At the bottom of the pyramid, people are characterized by the informality of their economy and their business activities. They live in rural areas, have no bank accounts, and don’t use basic services. So the authors identify several challenges that companies need to overcome: Consumers need to be able to acquire a company’s product, which means they need access to financing. Consumers currently lack the information they need for creating long-term demand for products. Companies need to overcome barriers of localization, logistics and infrastructure in activities that require the use of postal service payments. Incoming companies need to address the absence of government, which makes it hard to sign business contracts and puts their investments at greater risk. They need to make consumers aware of the implications of their options. Finally, they need to view consumers collectively in terms of their strong community spirit. That means companies must overcome local consumers’ traditional custom of viewing public services as something that they have a natural right to acquire through illegal means.
Innovation constitutes a crucial component in this strategy. “The most attractive area for business innovation and for reducing poverty is not in the product in itself but in the ways consumers acquire it, learn about it, learn to use it, finance its purchase, and get rid of it because the business model will vary from one country to the next,” the researchers write.
The base-of-the-pyramid approach can become a challenge for many companies because it tests their skill at making innovation and flexibility the key drivers of value in their strategy for competitiveness. This is also an area of experimentation where participants can co-create experience because “innovation at the base of the pyramid enables people to anticipate trends in developed markets,” the authors note.
In this sense, change also becomes a source of opportunity. The study outlines some of the unexpected successes and failures of products and services, as well as the inconsistencies between what companies offer and what the market really needs. For example, the authors explain that in the Philippines, the cost of a mobile phone is very high but people can afford the cost of a short text message. So the mobile service provider Smart Communications, using an innovative technology, broke down the SIM card into small units, to the point where today the Philippines is considered the country that has the highest volume of text messages.
According to the authors, consumers demand more and more solutions to problems, but they are only ready to pay for specific products. The base-of-the-pyramid approach enables companies to develop new ways to provide comprehensive solutions. Companies need to interact with their environment in order to overcome the factors associated with poverty. This will enable companies to create virtuous cycles based mostly on their skill at co-creating and developing experience-based networks that take advantage of the skills and investments of others outside their company. Thanks to this approach, companies can replicate these sorts of models on a larger scale and create new competitive advantages and new barriers to imitation.
As the authors point out, most corporate experiences at the base of the pyramid are Corporate Social Responsibility (CSR) initiatives. But some companies are trying to leverage these sorts of experiences to exert a more decisive influence on their core strategy and core business operations. Some companies that apply the lessons of their social activities at the base of the pyramid to their key business strategies will be able to develop a new business model that deals “effectively and profitably with low-income markets and increases their own competitiveness,” says the study.
“When we look deeply into these business models, they provide us with new sources of innovation. They reveal how to provide value to customers at the base of the pyramid, and reveal how much value can be captured in the process of serving them through co-creation and through strategic networks. This sort of approach is critical when it is time to design and implement superior business models that really increase the presence of profitable businesses at the base of the period, and also cooperate significantly in the reduction of poverty. These companies also become environmentally responsible, and their competitiveness improves as a result,” Mutis says.