Most companies trying to sell products and services to the 4 billion people who make up the world’s poor follow the same model suggested by bottom-of-the-pyramid experts: low price, low margin, high volume. This means that companies offer products at an extremely low price point with low margins and hope to generate decent profits by selling enormous quantities.
However, it is becoming more and more evident that this model has a fatal flaw – it requires an extremely high market penetration rate. There are several case studies of well-meaning commercial ventures that were unable to make sustainable profits due to low penetration rates. One example is Proctor & Gamble’s Pur water purification powder. The product was offered at a margin of about 50% on par with that of the company’s products worldwide and had healthy penetration rates of 5% to 10% in four test markets. However, in the end the venture still failed to generate the expected revenue. P&G gave up on Pur as a business in 2005 and instead announced that the sachets would be sold to humanitarian organizations at cost.
As similar failures suggest, cost structures in low-income markets are critical as operational expenses, such as distribution, are much higher than those in developed markets. In addition, customer acquisition and retention for new products often require unusually intense and costly levels of high-touch engagement. Therefore, in order to be able to cover high operational expenses, much greater volumes are needed to break-even.
Whereas a business that starts off needing a 30% or higher penetration rate is considered to be built on a shaky foundation in developed markets, at the bottom of the pyramid this is a losing proposition. Erik Simanis, Managing Director of Market Creation Strategies for Sustainable Enterprise at Cornell University’s Johnson School of Management, suggests that companies need to elevate gross margins far above the company average by pushing down variable costs and boosting the price consumers are willing to pay per unit. He also claims that companies need to raise the price point for a single transaction and concludes that this combination of higher margins and higher price points increases the contribution generated from every transaction.