Thursday, August 24th, 2006
In 2004, C.K. Prahalad, a professor at University of Michigan’s Ross School of Business published the groundbreaking book “The Fortune at the Bottom of the Pyramid.” The basic thesis is that multinational corporations (MNCs) have concentrated their sales and marketing efforts on the richest citizens of the world while ignoring the 4 billion consumers who live on less than $2 per day at the Bottom of the Pyramid (BOP).
He asserts that introducing market choice to the poor will free villagers from local monopolists, creating a virtuous cycle of consumer access and improved product quality. MNCs that sell products in this enormous, underserved market stand to make hefty profit. And, as more and more companies turn their attention to the BOP, competition will drive private sector innovations that address the needs of the poor. By giving MNCs an economic stake in this market, they in turn will draw the attention to problems of governance.
Although the work is primarily empirical and draws too heavily from examples in India, the BOP argument is an intriguing one. It eschews the notion that concentrating on the poor should be relegated to a secondary “corporate social responsibility” initiative and takes an integrative approach to the private sector achieving what non-governmental institutions and multi-lateral lenders such as the World Bank have not: pulling billions out of poverty.
We should applaud the BOP adherents for their novel approach, an approach that too closely resembles the idealism typical of a first-year Peace Corps volunteer. It is only after the corruption, complacency, intestinal ailments, and constant economic opacity have wrung out the initial naiveté that the discussion becomes interesting.
And a dose of cynicism is exactly what Professor Aneel Karnani - also of the Michigan School of Business - introduces in a recently-released working paper, “Fortune at the Bottom of the Pyramid: A Mirage.” He asserts that:
“Rather than focusing on the poor as consumers, we need to view the poor as producers. The only way to alleviate poverty is to raise the real income of the poor.”
Professor Karnani’s basic thesis is that BOP de-emphasizes the role of government in providing basic services and that we must focus on building the capacity of the world’s poor by focusing on government failures in education, health, and infrastructure.
Unfortunately, non-governmental organizations have been focusing on failures of government for decades. Billions of dollars have been spent flying experts around the world to bolster child immunization rates, build water delivery systems, and advise on bankruptcy reform. As you can see from the map above, the last 27 years have been lean ones for many in the bottom of the pyramid. This is not to diminish individuals’ efforts or passion. It is only to acknowledge that it is a very difficult goal and multi-lateral institutions do not have a recipe, much less a consensus, of how to foster economic growth.
One of the positive side effects of the BOP argument is that it makes MNCs stakeholders in a new and underserved market. To be sure, there are fatal flaws in the logic and research initiated by Prahalad. But MBAs are new to development and we should embrace that wide-eyed optimism even as we critique shakey methodology.
Is there a Market at the Bottom of the Pyramid?
Karnani points out one inexcusable fallacy in Prahalad’s work: market definition.
Prahalad used the World Bank’s estimates for the number of people living on an income of $2 a day or less (poverty), and $1 a day or less (extreme poverty). Both poverty measures are at purchasing power parity (PPP).
Why is PPP important? Because no matter where in the world you spend $1 PPP it buys the exact same goods, regardless of local price. So that $1 PPP that the extreme poor earn in a day will buy you one loaf of bread in the U.S. Actual prices are much lower in developing countries, so that same loaf of bread might only cost $.10. The market at the bottom of the pyramid will not pay MNCs in PPP dollars; it will pay them in local currency, as Karnani explains:
“[Prahalad] claims that the BOP potential market is $13 trillion at PPP. This grossly over-estimates the BOP market size. The average consumption of poor people is $1.25 per day and assuming there are 2.7 billion poor people, which implies a BOP market size of $1.2 trillion, at PPP in 2002.
“From the perspective of a multi-national company from a rich country, profits will be repatriated at the financial exchange rates, not at PPP rates. In that case, the global BOP market is less than $0.3 trillion, compared to $11 trillion economy in the US alone – making the BOP a difficult place to look or a fortune.”
Another problem is that the poor spend about 80% of their income on food, clothing and fuel. Suddenly the $300 billion market at the bottom of the pyramid shrinks to $60 billion of disposable income at current exchange rates. Spread amongst 2.7 billion people, that’s about a nickel a day for disposable income.
Karnani also takes issue with the number of poor:
“Prahalad states that there are more than 4 billion people with per capita income below $2 per day at purchasing power parity (PPP) rates…. Most researchers argue that the World Bank already over-estimates the number of poor people, with some researchers estimating the poor at 600 million (The Economist, 2004).”
There’s no shortage of poor, I’m afraid. Sanjay Reddy and Thomas Pogge of Columbia University have written a persuasive paper that critiques World Bank calculation of the number of poor in the world. While they give no new estimate, it’s likely that the world’s poor have been undercounted:
“There is some reason to think that the distortion is in the direction of understating the extent of income poverty.”
So the bottom of the pyramid is left with billions of poor who have no money. Does this invalidate Prahalad’s entire thesis? More on that tomorrow.