Curb Your Social Entrepreneurial Enthusiasm

Is there really a fortune at the bottom of the pyramid? C. K. Prahalad’s famous text suggested lots of money could be made by serving the world’s poor, and a new book by Paul Polak and Mal Warwick makes similar claims. But this opportunity isn’t for everyone.

Polak is a legend in social entrepreneurship circles, a former psychiatrist who started designing products for poor communities and has since sold millions of units. I’ve used his writings and speeches in my course at New York University on the role of the private sector in poverty alleviation. His latest book, The Business Solution to Poverty, says that the 2.8 billion people who live on $2 a day or less constitute a multi-trillion-dollar market. But it’s not that simple.

According to the World Bank’s database, there were indeed a maximum of roughly 2.8 billion people living on under $2 a day between 2000 and 2010. Multiply those numbers by 365 days, and they could indeed have spent about $2 trillion a year. It could have been more — some countries did not report any poverty figures — but it also could have been less, as the minimum numbers from the same period cover about 2.2 billion people.

However big the group was, the $2 figure was the maximum daily income to be a member. Many of these billions had lower incomes, but using $2 now allows for some income growth in the intervening years. The problem is that this $2 in purchasing power in a poor country is not the same as $2 in sales for a foreign company. In truth, the $2 figure is a measure of local purchasing power compared to prices in the United States in 2005; a person "living on $2 a day" is actually living on the amount of local currency needed to buy the same goods and services that $2 would have bought in the United States in 2005. Converted to greenbacks, that local cash might be worth far less than $2, since prices tend to be lower in poor countries.

This difference may not matter to local businesses, but it does to foreign firms. And Polak and Warwick’s book, which is priced by the publisher at $27.95, is clearly aimed at wealthy countries, or at least wealthy English speakers. To this audience, the cash equivalent of $2 in local purchasing power in a poor country would almost certainly yield well below $2 in repatriated revenue. Adjusting for both the currency difference and the potential overstatement of the poor population cuts the size of the market in half. For an American company, the actual opportunity might be to get a piece of a market worth a little over $1 trillion.

That’s still not too shabby. If all the poor lived in one country, it would have an economy roughly the size of Spain’s. Moreover, unlike the Spanish, this country’s population would be spending almost all of its annual earnings. That’s not great for families, but it does make the market bigger for companies.

At such low incomes, most families are saving very little. Very few at all have savings accounts, since access to banking is scant at best. Payment of taxes is also minimal, except indirectly. Many poor people work and shop outside the formal economy; in the poorest countries, half the economy may operate in the shadows. Where tax systems are more developed, the low incomes of the poor may still be exempt.

In this respect, the global poor’s buying power is real. Yet outsiders might have a hard time entering some parts of their market. For example, it might be difficult to convince a poor family to buy housing or pay for religious ceremonies and festivals — often two major items in the annual budget — from new sellers. And for other products, from local delicacies to haircuts, families might prefer established local purveyors.

Even if the bulk of poor households’ buying power were still available to new entrants, there would be other possible limits to their consumption. Just how many different goods and services would the households really buy? In rural areas, a local shop might stock 100 different items. In cities, that number might rise. Still, there’s a tradeoff: the more variety a family has in its spending patterns, the less often it will buy any one item.

For a given product — say, toothpaste — the revenue available from poor households worldwide might be on the order of $10 billion, or one hundredth of the total market. In a given country, though, the amount could be much smaller.

Polak’s market spreads across many countries but is concentrated in just a few. More than half of the 2.8 billion people cited by Polak and Warwick lived in India and China. Indonesia had about 5 percent, and only nine other countries had more than 1 percent of the total. In any of the other 100-plus countries where close to one-fifth of the poor lived, the market might offer less than $100 million in revenue for a given industry. In about half of them, it would be less than $10 million.

At this point, the numbers begin to look perilously small. Products sold to poor people usually have low prices, so the margins are low, too. As Polak himself is fond of saying, "If you can’t sell at least a million of them, don’t bother." But how many companies could sell a million units in a market worth only $10 million, especially if it were costly to enter?

This is the fundamental issue in serving the base of the pyramid. There are low-hanging fruit in some countries and industries, but there are also hundreds of millions of people living in areas where the potential economies of scale are much smaller. The world can make a lot of progress against poverty by picking the low-hanging fruit, but it will need other strategies to reach the higher branches of the tree.