Investment and Market Environment

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Credit: Robert Finocchio and Solar Sister.

Credit: Robert Finocchio.

This section provides a rundown of the market and investment environment for social businesses who seek to operate in sub-Saharan Africa (SSA).

Credit: Robert Finocchio and Solar Sister.

Credit: Robert Finocchio and Solar Sister.

The customer base and business environment

The base of the pyramid in SSA is very diverse culturally, economically, and geographically.  70% of rural Africans are smallholder farmers who make a living growing subsistence crops such as sorghum, maize, cassava, yams, and rice.  Farmers in many regions also grow cash crops for global and regional markets such as coffee, sugar, palm oil, cacao, and rubber.  In urban areas, unemployment rates are high and jobs are difficult to find for people who have recently migrated from rural areas.  Many of the urban BoP earn their livelihoods through their dealings with the informal economy, which employs about 80% of the labor force in SSA and accounts for 55% of the region’s GDP.

Furthermore, there are a number of different ethnic groups in SSA that speak a number of different languages and engage in different cultural practices.  Ethnic tensions are high in certain regions, and in the past, these tensions have erupted into violence.  These numerous cultural barriers, geopolitical divisions, differences in livelihoods, and ethnic divisions should be considered by an enterprise that is seeking to scale into new regions.  Business models or strategies that worked in one region may be useless in another.

Solar lighting market

Rapid innovation and reduction in the cost of inputs in the solar power and light emitting diode (LED) sectors in the past decade or so have allowed affordable, rugged, portable solar lanterns and solar home systems to become marketable to the base of the pyramid.  A number of businesses have already capitalized on the opportunity to provide cheap lighting to marginalized communities across the world through the use of solar powered lighting.

Solar lighting products generally come in two forms: pico-powered lighting systems (PLSs) and solar home systems (SHSs).  PLSs are small portable lanterns or floodlights that have a built in or attachable solar panel for charging.  Higher end PLSs have value-added features such as mobile phone charging, grid charging, and multiple brightness settings.  Solar home system (SHS) are larger solar lighting and mobile phone charging systems that are installed in a residence.  Both product types are offered at a range of price points by a number of different enterprises and come with their own advantages and disadvantages.  Because PLSs tend to occupy much lower price points, the PLS market has been growing in SSA considerably faster than the SHS market.

Technological advancement has paved the way for higher quality, more efficient, and more affordable products.  By 2020, customers can expect to receive PLSs with double the battery life and five to ten times the brightness as they had in 2012.  The overall price of a PLS is also expected to drop by 35% during the 2010-2020 period.  Costs have fallen even more rapidly than expected, so the reductions may be even greater than projected.  However, it is important to note that most enterprises outsource manufacturing to countries such as China and India, where the costs of labor are rising.  This is expected to increase labor’s share of product cost structure and even encourage manufacturers to relocate production to service areas as labor prices become too high to continue offsetting the cost of overseas transport.

An especially important feature is mobile phone charging capabilities.  Cell phone penetration in Africa continues to increase.  By mid 2012, there were an estimated 735 million mobile phone subscribers in Africa in total, and by 2015 the number of off-grid subscribers alone is expected to total around 400 million.  Africans use cell phones to make payments, communicate with friends and family, and look up information on the market prices and availability of certain goods.  The issue is that mobile phone penetration is expanding faster than charging infrastructure, which has led to a shortage of mobile charging points.  PLSs with the ability to charge mobile phones are a workaround to this problem and allow families to charge their phone(s) for free without having to pay someone to charge it for them or travel long distances to access a charger.

Credit: Robert Finocchio and Solar Sister.

Credit: Robert Finocchio and Solar Sister.

Some enterprises are also leveraging mobile money by implementing a pay-as-you-go (PAYG) system that utilizes SMS payment technology.  This allows for the PLSs to be sold at a very low upfront cost while customers can pay for lighting as they need it.  Other enterprises work with MFIs that are able to leverage mobile payment so that BoP customers can pay off their lighting products on microcredit.

SHSs involve a solar panel module that is placed or attached to the roof of a residence, which is hooked up to a central charging/control box.  Lights are then placed in different rooms and connected to the control box by wires.  The result is something that resembles a home lighting system much like what one would find in the developed world.  Since SHSs are more expensive (often on the order of several hundred US dollars per system), they have not achieved as high penetration and are often purchased on credit.

At the present moment, solar lighting products have relatively low penetration rates, but adoption rates are high.  In Q4 of 2012, there was an estimated 1.4 million quality-verified PLSs being used in sub-Saharan Africa.

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Source: Lighting Africa

As shown by the graph, sales have grown at a near-exponential rate over the past few years.  This growth is being driven by a number of factors, including lagging grid growth, the need for more efficient mobile charging platforms, growing expenditures on lighting, and the fact that PLSs are vastly superior to traditional lighting sources.  Because penetration rates in Africa were only about 4% in 2012, this geometric growth pattern is not expected to stop any time soon.

Cookstove market

For decades, international efforts by institutions such as the World Bank and United Nations foundation have pushed for the widespread adoption of improved cookstoves in sub-Saharan Africa.  Unlike the technology that goes into a PLS or SHS, improved cookstoves are not new.  Price has always been more of an issue than lack of technology.  There have been a number of programs in the past to distribute clean cooking technologies, but in recent years social enterprises have stepped into help accelerate adoption.

Malaika jiko

Wisdom Stoves’ malika jiko.

 There are a number of different clean cooking products in the sub-Saharan market that use a wide variety of fuels and occupy different price points.  Some cookstoves, such as the Kenyan ceramic jiko (KCJ) are designed to use the same fuels that the BoP is used to, and are simply more efficient and less polluting.  Others, such as Wisdom Stoves’ M1, implements relatively new technologies such as biomass gasification to boost efficiency and completely eliminate soot.  Others still, such as SMEFUNDS’ KIKE Green Cookstove, use newly introduced fuels such as ethanol chafing fuel or compressed biomass pellets.

Role of finance

Most BoP customers cannot afford to spend more than 20-30% of their monthly income on a potentially life-changing product.  Considering that 47.5% of people in sub-Saharan live on under a dollar a day, this would normally make even many of the most affordable energy products too expensive for the majority of the BoP in SSA.  It follows that most enterprises have found a way to save their customers the trouble of trying to afford upfront costs by developing a method of paying the product off.

Utilizing microfinance is one of the most common solutions that a social enterprise will implement to help BoP customers pay for the product.  There are a number of ways to go about this.  Some enterprises offer in-house financing, while others partner with other finance providers such as local banks and microfinance institutions.  There are a number of different finance institutions of varying degrees of scale and formality that social businesses partner with, namely microfinance institutions (MFIs), savings and credit cooperatives (SACCOs), rotating savings and credit associations (ROSCAs), communal lenders, and banks.

Traditionally, many social enterprises have partnered with MFIs, SACCOs, and other local-level finance institutions and organizations.  A symbiotic partnership is established between the two parties where the financial institution handles finance, marketing, and risk while the business takes care of manufacturing, distribution, and the replacement of defective products.  The roles of each party may change depending on the business model.  However, there are a number of disadvantages associated with such a partnership.  The transaction cost to loan size ratio is often very high, especially in the case of an MFI partnership because MFIs are less present in more isolated communities.  This is especially a problem for products that occupy lower price points.  Working with smaller, more present, local-level players such as SACCOs, ROSCAs, and communal lenders often reduces transaction costs, but these lenders often do not have as many financial resources and lack adequate managerial capacity.  This makes taking on the responsibilities associated with such a partnership logistically challenging for these sorts of credit providers.

With mobile phone penetration in SSA skyrocketing, mobile phone-enabled PAYG systems are really taking off.  Products are often sold at an extremely low upfront cost, and customers prepay via scratch cards, mobile payment, or by dealing directly with a vendor or representative.  This is more common in the electric lighting and mobile charging sector, but there are some cookstoves that have adopted PAYG technology (for example, a stove that turns off its ventilation fan after the prepayment expires, thus making the stove less efficient).  PAYG provides customers with a powerful incentive to pay off their product, because if they do not make payments the product will stop functioning and be useless to them.  PAYG can be undertaken either by the enterprise itself or by a third party financial institution.  Oftentimes, PAYG leverages mobile money platforms, which are now widely used in SSA as a more convenient way of making payments.  It allows customers to avoid the hassle of travelling to a vendor to make payments and saves distributors and finance providers the hassle of sending a person to remote villages to collect payments.

For all but the cheapest products, which normally would include consumer products such as fuels, financing is often necessary to make a product affordable to BoP customers.  In many cases, customers are willing to pay for a product such as a PLS, SHS, or cleaner cookstove but lack the ability to pay.  Thanks to financing options, many customers who would otherwise be unable to take advantage of the life-changing benefits of products offered by these products can now fully capitalize on them.

Product distribution

Distribution to the BoP is particularly challenging in sub-Saharan Africa, which as a region lacks transportation infrastructure and in many places local retailers who may otherwise serve as distribution centers.  This makes attaining last mile distribution costly and difficult.  Reaching some of the more impoverished communities often requires travelling for miles along unpaved roads.  In order to cope with these conditions, many social businesses have adopted a number of innovative distribution models to get their product to market.  Whether a model is effective is dependent on whether it is suited to the location it is being implemented in.

Social businesses often partner with an institution such as an MFI, NGO, or a local retailer to facilitate distribution.  Many local retailers are mom and pop shops that also sell kerosene, batteries, cookstoves, and other energy-related products that are already widely used by the BoP.  Other retailers are specialized franchise-based distributors such as hardware stores, supermarkets, and mobile phone shops.  By getting their products to these retailers, social enterprises save costs associated with hiring a distribution team and travelling into remote communities to attempt to sell their products.  There are a few disadvantages with this model, however.  Gross margins for the SE are often lower, and distribution to areas that lack a compatible retail center is impossible.  If the distribution partner is an NGO, however, achieving last mile distribution may be easier because these organizations often have the resources to penetrate deep into the most remote areas, but the range of products the social enterprise can distribute may be limited due to the interests and capabilities of the partner institution.  Despite the drawbacks, utilizing retail channels is usually preferred by social enterprises because these sorts of distributor-dealer networks already exist in SSA and are relatively easy to access.

Some enterprises take it upon themselves to distribute the product.  In this case, the product is usually shipped from the manufacturing location and stored in a warehouse or other proprietary storage facility.  These enterprises employ a sales team to deliver the product from the storage facility to the last mile customer.  This method is excellent for reaching the last mile and has a higher gross margin because it cuts out transaction costs associated with dealing with a partner.  However, it also requires a lot of resources including fuel for transportation, working capital to hire and retain a sales force, and extra time and energy.

Manufacturing and product sourcing

Generally speaking, in sub-Saharan Africa, where products are manufactured depends on the nature of the product and the location of the target market.   Products that are more technologically complex are manufactured in places with the proper manufacturing capabilities.  Oftentimes this place is China.  For example, approximately 86% of PLSs that were sold up to 2012 were manufactured in China, while another 5% were manufactured in India.  In these countries, labor costs and the costs of inputs are cheap enough to offset costs associated with shipping.

For less technologically intensive products such as cookstoves, manufacturing is often done locally.  This employs local labor, thus creating jobs and reducing shipping costs.  Companies that manufacture their own fuel will often invest in manufacturing plants close to target markets.  For example, Emerging Cooking Solutions, which serves Zambia’s Copper Belt, has built manufacturing plants to process sawdust into pellets that are then used as cooking fuel for improved cookstoves, which are manufactured abroad.  Other cookstove enterprises, such as Wisdom Stoves, carry out manufacturing locally in facilities that employ local labor.

As labor costs in China and India continue to rise, it is likely that more and more manufacturing for products such as PLSs and SHSs will be carried out domestically.  This will both reduce costs for the customer and stimulate the economies of many African countries.  Furthermore, Africa is a resource-rich continent, so many of the raw materials are already present.  The only thing that is lacking is infrastructure.  Currently, investing large sums of money into manufacturing infrastructure is infeasible because demand is not high enough and because outsourcing is still more cost-effective despite high shipping costs and tariffs.

Investment and funding

Acquiring investment and grants can be extremely difficult for social enterprises, yet it is essential for them if they are to grow to a point where they break even and become cashflow-positive.  Traditionally, Africa as a whole has received aid rather than investment.  However, in recent years, SSA has been attracting a number of impact investors and socially-motivated venture capitalists who have helped social enterprises get their feet off the ground.  Furthermore, social enterprises can take advantage of grants and donations from philanthropists, charities, private individuals, and initiatives such as GACC.

The demand for investment is huge, and thus the investment environment is highly competitive.  Presently, there is a large gap between demand and supply of finance.  Early stage small to medium-sized enterprises (SMEs), including social businesses, currently demand an estimated $140 billion USD a year.  Yet, impact investors have invested just $8 billion USD in African businesses to date.  Social enterprises only have captured a fraction of this.  They are not particularly attractive destinations for traditional investment because they generate very large social returns on investment (SROI) but have much lower profit margins and thus do not generate very large financial returns on investment.  With regards to impact investment, many social enterprises, especially earlier stage enterprises, find it difficult to attract impact investors because they do not have the resources to implement impact monitoring systems.

The type of capital an enterprise can receive is highly dependent on its business model.  For-profit enterprises may attract venture capital investment, which deliver large sums of money (often in the multi million dollar range) in exchange for a stake in the company.  Venture capital investment in Africa is growing rapidly.  It nearly doubled from 2012 to 2013, reaching an estimated $3.2 billion USD in that same year.  The true value is higher, as records of many smaller private equity deals with SMEs are often not kept.  Opportunities are growing in the SME sector, and a considerable shift in investment towards SMEs is predicted.  This is a shift that many social businesses will be able to capitalize on.

Hybrid enterprises and nonprofits usually cannot access the larger sums of money that are doled out by private investors and venture capitalists, so they receive the lion’s share of their funding from grant money and private donations.  It may come from international initiatives such as GACC, or be awarded by international and private institutions and foundations such as the Skoll Foundation.

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