The “Base of the Pyramid” — Gold Mine or Chimera?
As is increasingly well-known, there are approximately four billion people in this world currently living on $2 or less per day. This group, at the bottom of the socio-economic pyramid, has been termed the “base of the pyramid” (or BOP) by academics and others, beginning in 2002 with the seminal article “The Fortune at the Bottom of the Pyramid” by two U.S.-based academics, Stuart Hart and C.K. Prahalad.
The basic premise of the initial iteration of the concept (“BOP version 1.0”), was that, contrary to both intuition and popular belief, poor people do in fact have considerable purchasing power, and are indeed responsible borrowers. On this latter point, the evidence has subsequently borne this out in spades; repayment rates for the celebrated Grameen Bank in Bangladesh are typically in the range of 99%, a figure that commercial bankers at the likes of JPMorgan and Citigroup can only envy. Today, the Grameen Bank has over 7 million customers, 97% of them women, and has loaned out an astonishing $6 billion, at an average loan size of only $100. It has also spawned a variety of successful spin-offs, including Grameen Phone. In recognition for his immense social and economic contribution in founding the bank, former (reformed?) economics professor Muhammud Yunus was deservingly given a Nobel prize in 2006.
BOP 1.0 was focussed on the poor qua consumers, and argued that, for companies nimble, flexible, and committed enough, the BOP could in fact serve as an attractive and growing customer market, and a useful hedge against the growing probability of relative saturation and stagnation in developed markets. After an initial rush of enthusiasm, however, critics began complaining that BOP activity was simply another, new strain of economic imperialism and exploitation, merely “selling to the poor”, with most of the benefits flowing to the vendors, not their ultra-low income customers. We believe that, while perhaps overstated, there is at least a grain of truth in this allegation. Thus was born “BOP 2.0”, which, while not replacing Version 1.0, has taken the concept to another level altogether.
Under BOP 2.0, a more egalitarian model is emerging, with the poor as “co-creators” and co-owners of new micro-enterprises providing goods and services uniquely well-adapted to their social, economic, and cultural environments. In theory, the skills, experience, resources , and “distinctive competencies” of both a major corporation and a local village are combined synergistically, to create entirely new and locally embedded enterprises. So BOP 2.0 views the poor not merely as consumers, but as an enormous, untapped resource of human capital on the creative side of the commercial equation. Under this approach, local communities get much more than simply new products and services; they generate jobs, entrepreneurial skills, new income, economic and social development, and, perhaps most importantly, dignity. Sounds idyllic, doesn’t it?
The only problem is that BOP 2.0 is devilishly difficult to pull off successfully in practice, and there are precious few real-world examples where it has been truly effective. Clearly, the challenges of conceiving , executing, and sustaining such game-changing initiatives are prodigious. However, with the developed world both ageing and in relative economic stagnation, we at IPCM believe that BOP 2.0 , 3.0, and any subsequent iterations are the way of the future. For sustainability-oriented investors, as always, there is both a sustainability angle and an investment angle here.
The sustainability implications of the BOP are relatively obvious. On the social side of the sustainable development ledger, both the individual and societal economic benefits of lifting 70% of society out of extreme poverty are both evident and extraordinarily compelling. In addition, putting an end to the current situation where 70% of the world’s human capital potential is virtually wasted would generate both economic and social capital on an unprecedented scale. On the environmental side, the potential benefits are no less compelling; it is well known that the #1 cause of environmental degradation in the emerging world is poverty. Reduce the poverty, and one reduces the adverse environmental impacts accordingly. Moreover, from a planetary perspective, placing the world’s 4 billion poor on a more environmentally sustainable development trajectory is little short of an imperative. If an additional 4 billion people were ever to achieve anything like the current wealth and consumption patterns of the OECD countries, the carrying capacity of the planet would be exceeded several times over.
If the sustainability benefits of the economic empowerment of the BOP are obvious, however, the implications for investors may be much less so. For Inflection Point Capital Management, the argument is quite clear. Our overall investment philosophy is that a rigorous analysis of companies’ performance and strategic positioning on environmental, social, and other “non-traditional” factors such as innovation and adaptability can be a robust proxy and leading indicator for the overall management quality and execution capabilities of the firm. These, in turn, are arguably the greatest single determinants of its financial performance, at least in the medium and long term. Well, if one wants to find an excruciatingly demanding test of management quality, the ability to conceive and execute effective strategies for tapping the potential of the BOP is difficult to beat. Virtually every aspect of both the mindsets and the business models which have been successful in developed and affluent developing markets need to be reinvented. In short, show us a company which can dramatically out-perform its sector peers on the BOP challenge, and we’ll show you an exceptionally well-managed company, period. The fact that most investors completely ignore this factor simply adds to the information advantage of those who do not.
At least, that’s the theory. While several of us were still at Innovest Strategic Value Advisors, we decided to put that investment thesis to the test. We focused on Latin America, where BOP challenges are acute. We decided to use BOP capabilities and positioning as proxies for companies’ overall management quality. The second and perhaps even more important part of our thesis was that this kind of analysis, combined with traditional fundamental analysis, could help generate financial out-performance. Our “laboratory” was the dominant large-cap index in the region, the MSCI Latin America. Over the course of months, we analyzed each of the 120+ companies in the index, through the prism of BOP issues. We then used the results of that analysis to “tilt” the regular index, slightly overweighting the leading companies and underweighting the laggards. Clearly, the specific BOP opportunities and challenges varied significantly from sector to sector, but the overall themes remained quite constant. We then back-tested our “BOP-enhanced index”, and compared its 3 and 5 year historical performance to that of the underlying benchmark. The results: the BOP index out-performed the benchmark very modestly over a 5-year period, and by a significant margin ( 200 + bps) over the more recent 3-year period.
Now for the two major caveats. Firstly, since our test was not done live and in real-time, the usual limitations of any backtest methodology apply, and it would be reckless to put too much weight on the results. Second, the process was, as can be imagined, extraordinarily labour-intensive, requiring direct interviews with each of the companies. It was not, and cannot be, an exercise for the faint-hearted or under-resourced investor. But , having said that, we believe that the experiment can provide investors with several important “take-aways”:
- There appears to be at least a modest “sustainability alpha premium” associated with superior performance in tackling BOP issues.
- As we would have expected, that premium is growing larger over time, as BOP issues become more critical to the competitive and financial success of companies in emerging markets.
- As the economic center of gravity of the world shifts inexorably towards emerging markets in general, the investment implications of BOP issues can be expected to increase still further
- If those hypotheses are correct, high-quality research on BOP issues can provide investors with a significant information advantage, one which cannot be easily or quickly overcome.
Up until now, BOP issues were largely the concern and preserve of NGOs and academics. We believe that it is high time that they hit the radar screens of sophisticated, long-term investors. The social, economic, environmental, and investment performance benefits could be substantial.