Doing business with the bottom of the pyramid: The Ayala Group experience

Posted at 10/13/2008 11:42 AM | Updated as of 10/13/2008 3:31 PM

Our experiences in developing the business models in two of our business units--Globe Telecom and Manila Water—have given us significant new insights in learning to address many of the challenges to serving these large and growing low-income communities.  While Globe’s business model evolved over time, Manila Water’s model targeting the low-income segment was central to its strategy from the very beginning.

Globe Telecom

Globe’s initial business model targeted the upper income, post-paid retail market and focused on the traditional wealth centers of Manila and the more affluent secondary cities.

But in due course, Globe realized it was important to extend its mobile network throughout the entire country to ensure a high quality of service and sustain its growth. However, the top end of the market alone was too small to support the capital expenditures required for a nationwide roll-out. Any growth strategy required the company to expand more aggressively into the lower C and D consumer classes, which represented the middle and lower-income customers.

The shift in target market immediately posed affordability and acquisition issues:

First, the cost of handsets was steep, making the accessibility of the units for low-income customers prohibitive.

Second, eligibility standards used for the post-paid model were also high, making it difficult for others to meet these and, for those who did, the monthly payments were a strain on their incomes.

To address these, Globe switched from a post-paid model to a pre-paid model. Globe sold pre-paid SIM kits with pre-paid credits available in call card form in lower denominations i.e. P1,000, P500, and P250 and today this can be as low as P100.

Subscribers only needed to pre-register and secure their own handsets. From there it was simply a matter of purchasing the cards and users could easily top-up with amounts as needed.  There was no need for a “credit” check as all amounts were now paid in advance.

Technology helped

Admittedly, timely technological developments helped support Globe’s shift to the pre-paid model:

1.  Retail prices of SIM cards began to fall from close to P1,000 in 2000 to P100 by 2004.

2.   Handset prices also began to decline (i.e. no-frills cell phones can be acquired for as low as P1,050) and an active secondary market for handsets that put prices within reach of a much wider range of consumers.

These two factors--the shift to the pre-paid model and the increased affordability of handsets--helped address some of the affordability and collection issues, while also dramatically expanding Globe’s market share penetration. Under this pre-paid scheme, eligibility requirements were also no longer required as anyone who could afford a pre-paid card could avail of mobile phone service. Pre-paid cards also rendered the billing and collection challenge completely obsolete.

The pre-paid model brought to market an entirely new model of pricing and delivery which led to a market expansion never anticipated in the Philippines. The market expanded 56 times from that moment, and has reached an estimated 72 million today. The market penetration rate continues to rise from 27% of the population in 2003 to close to 60% today.

Innovations

However, while further refinements to the pre-paid model were made along the way, we continued to encounter new challenges as we sought to expand to much lower-price points:

1. We continued to encounter affordability issues. The P500 and P300-call cards were still priced high for some low-end income users. This was a problem. Producing pre-paid cards to sell below P300 was cost inefficient.  

2. Security issues. The pre-paid call cards were vulnerable to theft as these were as good as cash; and  

3. The rapid take-up of pre-paid call cards put pressure on Globe to further expand its presence among low-income communities. They faced the challenge of developing the lower D economic market more extensively where infrastructure was a basic problem and the physical distribution of the pre-paid call cards was cumbersome.

Globe developed several key innovations to address these problems:

1. Over-the-Air solution. Globe found a technology based solution and used an electronic over-the-air (OTA) pre-paid credit reloading system for subscribers to be able to purchase credits from Globe retailers and dealers nationwide for voice and text messages. Using SMS technology, end-users pay a licensed OTA retailer or distributor the peso equivalent of the prepaid credit purchased which is electronically transferred from the retailers’ SIM to the end-users’ SIM. These prepaid credits can either be used by the recipient or transferred to another Globe prepaid subscriber. This had the advantage of lowering costs and making value transfers easier and less risky.

Globe drew from the experience of fast-moving consumer goods companies using the “sachet marketing” approach to sell the pre-paid cards. This made phone service even more affordable as smaller denominations of P100, P50, and P25 were now possible with OTA and allowed subscribers to reload in even smaller P1 increments. This eventually led to the development of a load-sharing service that allowed even post-paid subscribers to pass on prepaid credits through SMS.

The OTA system addressed the security and distribution challenges as these prepaid credits are bought by wholesalers and sold to subscribers electronically, eliminating costly and time-consuming transportation charges.

Expanded network

The impact of this OTA electronic loading innovation was astounding.

It has made a huge impact on Globe’s ability to expand its distribution network while at the same time providing revenue generating opportunities for retail outlets in low-income communities, which are traditionally small mom & pop vendors or small village retailers typically called “sari-sari stores”.  By tapping into this non-traditional network, Globe is able to distribute to wholesalers much more frequently, in smaller lots, and even in hard-to-reach rural areas.

 It reduced credit risk and the overhead required to set up shop and at the same time empowered small and medium scale retailers to create a source of livelihood.

Globe began with 50,000 retail distributors, this community of entrepreneurs has grown by over 12 times to more than 600,000 by the end of June 2008.  Combined, they generate revenues of at least P40 billion yearly.
Electronic loading has been expanded and developed as a platform for M-commerce. Together with our capabilities in banking, it has opened an exciting possibility of the service being used to deliver microfinance services to low-income consumers. Globe has rolled out a facility to assist and facilitate access to micro credit through SMS under its MICRO ASENSO TEXT FACILITY which enables low-income households, small and would be entrepreneurs, locate the nearest Microfinance Institution (MFI) in their community through SMS. Today, there is an estimated registered base of 2.5 million micro-borrowers.

Bank of the Philippine Islands

Microfinance is an exciting field that has tremendous potential to change the way small scale entrepreneurs develop in our emerging markets. Within our group, the capacity for synergy between the financial resources and lending experience of our bank, Bank of the Philippine Islands (BPI), and Globe Telecom is exciting. There are initiatives to use mobile phone technology to achieve our dual objective of maximizing the outreach of our microfinance efforts to as many micro entrepreneurs as possible and at the same time lowering the cost of delivering micro-banking services.

BPI has engaged the bottom of the pyramid more actively over the past few years:

1. The bank has formed a MicroFinance Unit back in 2006 and is now one of the largest privately-owned provider of wholesale microfinance funding in the country, lending to 15 MFIs with a loan book of P385 million and with P220 million more in the pipeline.  
2. This is complemented with a capacity building program for MFIs and financial literacy lecture series designed for and targeted to the SME markets. The capacity building program for MFIs includes both a training program & a loan program. The training program is done in partnership with the Ateneo de Manila University where 10 microfinance training programs are held each year in various cities around the country. The loan program in turn is a subsidized loan to finance eligible capacity building programs of MFIs.
 
In tandem with this, BPI Family Bank has a loan building program that caters to the loan requirements of micro SMEs, many of which are located in the countryside.  Any increase in this activity has a multiplier effect on job creation.

The social and economic potential to tap into this market using current technology is large. We should have the capacity to reach out to more customers and give them access to a whole host of financial and communication products and services in the future.

Manila Water Co.

Manila Water’s business model, on the other hand, developed quite differently from Globe’s and considered the base of the pyramid as central to its strategy from the very beginning. It was important for the company to take an integrated perspective on its CSR and sustainability programs to ensure total alignment with its core business strategies.

Sustainable development issues that involve improving access to water services, protecting the environment, improving the quality of life, and increasing community participation and empowerment, lie at the heart of Manila Water’s business.

For this reason, it  cannot separate environmental and social concerns from its mainstream strategic business considerations. It was important for the company to take into account all environmental and social issues as part of its daily business decision-making across all levels of the organization.

From an organizational standpoint, Manila Water developed a corporate culture that encourages direct involvement in social initiatives from its inception. new employees start their training program with projects in low income communities. As they assume regular jobs, social metrics are included in their key performance measures that include the number of low income communities, public schools and health centers served. All levels of management have a regular program that takes them out on field.

The organization was structured and designed to directly address the challenges of the base of the pyramid. Eight Business Areas within the concession zone were set-up and empowered to address the needs of all customers in the major population centers. Each of the Business Areas was further broken down into Business Supply Zones and Territories which focused on contiguous communities that include low-income groups.

The main motivating factor for this set-up is that Manila Water realized early on that a lack of service to the low-income segments posed a real threat to the viability of their operations for several reasons:

Pilferage of water was prevalent among low-income groups. With the combination of an unaffordable one-time water service connection fee and the daily need for water, informal settlers would tap into the mainlines that are installed to service commercial and higher-income customers.

Illegal connections are a major source of damage to pipelines and infrastructure, which could increase capital expenditure requirements and impair service. These connections, installed with substandard materials and workmanship, also contribute to substandard water quality.
Failure to serve low-income segments has direct economic and quality of life issues, which can increase regulatory risk or risk of re-nationalization of a utility company like Manila Water.

What we faced then When Manila Water took over the concession a little more than a decade ago, it also encountered challenges typical to serving low-income groups:

• An infrastructure and acquisition challenge – urban poor communities did not have proper basic water facilities like faucets or toilets or in-house plumbing. Due to the high cost of in-house plumbing, most urban poor households do not prioritize these facilities. The lack of road networks also posed significant challenges to service expansion, particularly at the fringe areas of the service coverage.

• A collection challenge – Piped-in water was essentially a “post-paid” product as users are filled after consumption. Some areas did not have payment facilities provided by banking institutions and physical collection was difficult to render especially in the hard-to-reach low-income communities.

• Education and culture – There were two key aspects to this:

 a) Piped-in water is billed every month, while vended water can be bought offhand whenever one desires. Because of this and the fact that most urban poor households subsist on a daily basis, many of the poor communities preferred vended water, thinking that they may incur savings this way, when in fact they were paying ten times the cost of piped water.

b) Provision of water services also becomes a major challenge when the target community has developed a culture built around patronage politics, dole outs or non-payment of basic services, with an absence of good leadership among local officials and community participation.

To address these challenges, Manila Water devised effective delivery schemes, offering a menu of service delivery and payment options such as:
· single piped water supply
· clustered metering to mitigate pilferage
· flexible payment schemes where there was an option for installment payment for connection charges and water bills or collection through payment facilities located near their residences, which was patterned after the consumption behavior and cash flow cycle of the low income households.

Embedding in the community

More importantly, Manila Water embedded themselves within the communities by working with community leaders in bill distribution and collection, as well as developing flexible payment schemes.

They launched education campaigns and dialogues. A pre-requisite to the delivery of water services is social preparation and acceptance through information campaigns, dialogues with the community leaders and target customers, sharing of best practices from previous programs and harnessing community and peer pressure to ensure pursuit of common goals.

Manila Water embarked on an education program to talk to consumers about the risks to long-run water provision from illegal connections and pilferage.

They educated customers that vended water costs much more than piped water, and that it is of substandard quality which can impact health and quality of life conditions.

By setting up a decentralized organization geared towards the bottom of the pyramid, Manila Water was able to gain intimate knowledge of low income communities, enabling the company to offer appropriate programs and solutions to water problems.

The rehabilitation of their water distribution system was given priority by the company particularly for low income communities that are already connected to the distribution system, in order to provide for 100% coverage and 24 hour availability at the right pressure. This significantly improved their quality of life since they no longer had to stay up late waiting for vended water.

Low-income communities in the expansion areas were immediately connected as soon as the expansion mainlines were laid. This enabled them to realize cost savings as water delivered by tanks cost more than ten times the cost of piped in water supply. Manila Water has expanded this program to connect not only low income communities but also public institutions like public schools, markets, hospitals, orphanages, and jails.

As a way of “embedding” themselves in communities and creating a mutually beneficial ecosystem, small and medium scale enterprises within the low-income communities were tapped for certain components of the supply chain. These SMEs generated more jobs near the communities and these are being expanded to form Low Income Community Cooperatives that can manufacture/assemble small components needed for meter assemblies, as one example.

Unserved areas

Low-income communities benefited most from Manila Water’s model. In 1997 most of the low income communities did not have 24 hour supply and normally obtained water supply at night. Today, 99% of the population in Manila Water’s concession zone has 24-hour water supply.

The strategies and programs targeted towards low-income communities enabled the company to drastically reduce non-revenue water (NRW) or system losses from over 63% in 1997 to 20% in 2008. Through community participation and a menu of delivery/payment options, collection efficiency improved significantly. The collection cycle has gone down to less than 30 days from about 90 days at the initial years of the concession.

The reduction in NRW in turn produced additional volume of water which allowed the company to supply unserved areas, especially low-income communities while outperforming its service coverage obligations. The expansion of market coverage resulted in increased volumes and revenues from serving over 1.3 million low-income groups, which are now part of the company’s five million customer base.

This has opened opportunities for Manila Water to expand further into unserved areas in the rest of its concession zone and perhaps, other parts of the country.

Financial and social rewards at the base of the pyramid

In both of the examples of Globe Telecom and Manila Water, we have seen both the financial and social rewards of working and operating at the base of the pyramid. Business models designed to prioritize the low-income segment can be profitable and can achieve competitive rates of return while also providing a developmental impact that is both scalable and sustainable in the long-term.

From less than P3 billion in revenues in 1997, Globe now generates in excess of P60 billion in revenues, while reinvesting significant amounts of capital (e.g. P80 billion) the past five years alone, into new and often pioneering technologies. EBITDA margins are over 60% and return on equity is in excess of 20%. Shareholder value has also grown from P37 billion in 1999 to P207 billion last year.

Manila Water’s track record has also been beneficial for its shareholders with market value up 16 times since 1997, revenues nearly doubling over the past three years, and generating double-digit returns on capital employed.

The more important question from the standpoint of building an enduring business is whether these companies also created wealth for their low-income customers.

Globe contributes directly to the economy through the wealth it generates, the taxes it pays, and the suppliers it sustains. Wider access to communications expands access to finance, markets, information, education, and other basic services that altogether comprise a vibrant economy.

The 600,000 retailers of Globe comprise a veritable army of entrepreneurs, mostly from the small and medium scale businesses. Further entrepreneurial opportunities via the Internet have been opened by Globe’s Internet Café kit, which is a business-in-a-box solution for start-ups.

Globe has facilitated a whole new way of transacting with mobile payment and remittances services. This continues to grow in terms of subscribers and partnership with merchants and is now handling transaction values of around P6 billion.

Manila Water has helped generate significant cost savings to its low-income customers not only by providing piped water to replace vended water which costs much higher, but also freeing up greater productive time for families.  Regular affordable access to clean and safe water reduces many other costs such as avoidance of water-borne diseases. Its Livelihood and Vendor Development programs have also benefited more than 700 families and have generated a cumulative value of more than US$100 million worth of projects for small and medium scale entrepreneurs over the past five years.

These are excerpts from the speech Jaime Augusto Zobel de Ayala delivered during the Management Association of the Philippines conference on Oct. 7, 2008.