How to approach the "Base of the Pyramid"

Table of Content

Executive Summary

Table of figures

Overview of tables

List of abbreviations

1 INTRODUCTION
1.1 Background
1.2 Aim of the Master Thesis and guiding questions
1.3 How to approach the “base of the pyramids”
1.4 The product - eBook-reader

2 ANALYSIS
2.1 Country analysis
2.1.1 Selection of countries:
2.1.2 Scoring model
2.1.3 Selection of indicators
2.1.4 Results of country ranking
2.1.5 Conclusion
2.2 Industry analysis – introduction
2.2.1 Intensity of competitive rivalry
2.2.2 Threat of substitute products
2.2.3 Entry of new competitors
2.2.4 Bargaining power of customers
2.2.5 Bargaining power of suppliers
2.2.6 Bargaining power of governments
2.2.7 Conclusion
2.3 Business strategy analysis
2.3.1 Company Strategies
2.3.2 Pricing strategy for eBook-reader and eBooks
2.3.3
2.3.3 Product Strategy and partnerships
2.3.4 Revenues and income
2.3.5 Conclusion

3 How can the eBook-reader industry approach BOP markets?
3.1 Adapt products and processes
3.2 Invest in removing market constraints
3.3 Combine resources and capabilities with others
3.4 Leverage the strengths of the poor
3.5 Engage in policy dialogue with government
3.6 Conclusion
3.7 Final conclusion

4 Bibliography

ANNEX I: Analyses of BOP Market Potential

ANNEX II: Questionnaire

ANNEX III Potential Partners

Executive Summary

Four billion people live with less than 8 $ per day. Stuart Hart and C.K. Prahalad describe people living in this segment as “Base of the Pyramid”. They show that these four billion people are involved in economic processes: They consume, offer their manpower and their products on local markets and they run businesses. So far, the developed world perceived them as aid recipients. Especially multinational enterprises have not recognised the business opportunity at the base of the income-pyramid, focusing on wealthier customers in industrialised countries. Hart and Prahalad invented the idea that multi national enterprises can approach this huge market when they invest in innovative products and enable the poor to do business and integrate them in their value chain.

Based on this approach it was the objective of this research to analyse how companies involved in the eBook-reader industry can approach markets at the base of the pyramid.

This research is based on three analyses: A country analyses to identify market opportunities and threats; an industry analysis to understand the main forces within the industry, and a business strategy analyses to understand the potential competitors strengths and weaknesses. In a final step the key findings are taken to analyse if the identified strategies are sufficient for a successful and sustainable market entry.

In the country analysis Mexico, Columbia, Brazil, South Africa, Thailand, Kazakhstan and Macedonia have been identified as countries with favourable market potential within the BOP-segment and a positive educational, infrastructural and political environment.

The industry analysis has shown that the entry barrier is low for new competitors – resulting in a permanent changing environment. The threat of substitutes is rather high as long as customers prefer a general-purpose product like the mobile phone instead of an additional device for reading only.

In the business strategy three multi national enterprises, Amazon, Sony and Apple have been identified as companies with necessary strengths to approach the base of the pyramid. However, their prices for eBooks and eBook-readers are still too high for this market segment. Perhaps the companies can learn from the much smaller China based company Shanda Literature. With its low-cost solutions for online and offline reading it has performed an enormous growth and has developed a business strategy that could be easily applied.

Based on these findings and considering international recommendations, a strategy map has been developed for the eBook-reader industry. Companies can only approach successfully the base of the pyramid when they adapt their products and processes, invest in removing market constraints, leverage the strengths of the poor, combine resources and capabilities with others and engage in policy dialogue with governments.

According to the industry, 2009 might become the year of the eBook-reader. If produced at much lower costs than today and marketed as a tool for education, eBook-readers could become a useful tool for the base of the pyramid.

However, as all findings are based on a desktop study this research should be considered as a first step for orientation only. According to Hart and Prahalad, an open exchange and learning process between entrepreneurs, scientists, companies, NGOs and international development organisations is key to drive innovations at the base of the pyramid.

Table of figures

Figure 1: 5 trillion $ - Income distribution in BOP segments

Figure 2: Usage of different communication technologies in developing regions

Figure 3: ICTs and transaction costs

Figure 4: e-book reader – key elements

Figure 5: E-Ink compared to LCD-Display technology

Figure 6: Country Analysis: Group indicators and weighting of groups

Figure 7: Extension of Porter’s five forces model

Figure 8: Industry growth: US Trade Wholesale eBook sales

Figure 9: Position of substitute products (mobility, readability and interactivity)

Figure 10: Buyer’s workflow

Figure 11: Six forces based on industry analysis

Figure 12: Product strategy and value chain control

Figure 13: Price and market segment

Figure 14: Amazon partnerships – Kindle website example

Figure 15: Business partnerships and format strategy

Figure 16: Annual revenues 2008

Figure 17: Annual operating income 2008

Figure 18: Net profit margin 2008

Figure 19: Sales of eBook-reader devices in 2008

Figure 20: Competitors’ strengths and weaknesses

Figure 21: Constraints and Strategy matrix

Overview of tables

Table 1: Development of the BOP Strategy

Table 2: First selection of countries

Table 3: Overview indicator group – BOP-market

Table 4: Overview indicator group – Education and Skills

Table 5: Overview indicator group – ICT Infrastructure

Table 6: Overview indicator group – Political Environment

Table 7: Results of country analysis

Table 8: Summary of country analysis

Table 9: Overview on analysed strategies

List of abbreviations

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1 INTRODUCTION

1.1 Background

According to Hammond et al. (2007, p. 3) nearly four billion people, roughly two-thirds of the world’s population, live with less than 3,000 US$^[1] per year. The majority of this population at the “base of the pyramid” (BOP) lives in developing countries of Africa, Asia, Eastern Europe, Latin America and the Caribbean. Most of the poor can neither access nor afford similar products and services at a similar cost as wealthier consumers. In general people living in remote and rural areas have to pay even more compared to rich households for purchasing essential goods and services. This situation is described as “poverty penalty”, mainly due to inefficient distribution systems (market failure) or monopolies (state failure) (cp. Mendoza 2008). In addition, these poor households are extremely vulnerable due to related direct and indirect effects. For example, higher oil-prices increase costs for transportation and production and these factors indirectly increase food prices; global events such as the financial crisis 2008/2009 have a negative impact on foreign aid and remittance flows from abroad. In addition, there is “very little space left for poor households to adjust to potential economic instability” (UNICEF 2009 p. 26). Therefore these people need more opportunities to access new marketplaces and products in order to participate in economic growth.

One of these opportunities is access to more education – and more specific, access to better textbooks. This will be further elaborated, as it will lead to the subject of this research: According to Amartya Sen (2004) education is the most important aspect that enables people to achieve their freedom and to participate on the opportunities of global economic development. “To use the opportunities of global trade, ‘quality control’ as well as ‘production to specification’ can be quite crucial, and they are hard for illiterate or innumerate labourers to achieve” (Sen 2004 p. 144). However, in many developing countries, literacy rate is low, teachers are not well educated and books for education and teaching are rare or not affordable. In a recent publication UNESCO highlights the positive impact of available textbooks in local languages in the classroom on students performance from poorer households (2008, p.73). The same publication also concludes that many “Investments in textbook production (...) have often been one-shot, short-term projects that have done little to sustain local publishing capacity over the long term” (2008, p74). In a review of textbooks Searle claims that in many developing countries quality of textbooks is poor, mainly because of inadequate paper production facilities, low coordination between curriculum and manuscript development and too few institutions that ensure good quality of books (Searle, 1985). Most bi- and multilateral organisations support educational reforms, improvement of the curriculum as well as teacher training in order to improve the educational sector. Their efforts are supported by initiatives that focus on strengthening the publishing industry in developing countries, e.g. the African Publishers Network, the Bellagio Publishing Network and the network of Soros Foundations.

In recent years, a few organisations started to experiment with the use of low-cost technologies in the education sector in order to improve access to digital educational resources as an alternative to paper based resources. Background for this focus on end-user devices with integrated digital textbooks is the weak Information and Communication Technology (ICT) infrastructure in most developing countries that doesn’t allow students and researchers to access the Internet and relevant educational content. One of the most prominent low-cost devices is the so-called 100$ Laptop (XO-Laptop), invented by Nicholas Negroponte, founder and chairman of the “One Laptop per Child” (OLPC) non-profit organization. With the introduction of his low-cost laptop for a mass market he did in fact reduce the price of a robust laptop for children to about 150$ (The Economist, 2009b, p. 16). Hereby, he challenged the industry to invent cheaper notebooks, now generally known as netbooks. Although OLPC is claiming to focus on children, as major actors that would best know what to do with such a tool, the initiative is rather technology and hardware driven^[2]. For instance, by following this approach in a pilot project in Ethiopia, the role of teachers was partly devalued and it was not surprisingly that in some cases teachers banned the XO-Laptops from classrooms (One Laptop per Child News 2009). This experience demonstrates that the distribution and implementation of innovative technologies at the BOP requires a lot of testing and learning. However, the debate and studies on the sustainable usage and impact of computers and laptops in schools in developed as well as developing countries is ongoing and very controversial. With the introduction of Amazon’s eBook-reader a much simpler device for education is now on the market^[3]. As there was no research available on the possible introduction of eBook-readers in BOP contexts, the author decided to choose eBook-reader as subject for an analysis of countries and strategies to approach people living at the base of the pyramid.

1.2 Aim of the Master Thesis and guiding questions

The objective of this master thesis is to analyse how companies that are involved in the eBook-reader industry, can successfully approach BOP markets.

The following questions will be discussed in this research:

a) Which countries at the base of the pyramid offer the most promising market environment for the introduction of eBook-readers?
b) Which competitive forces define the e-Book-reader industry?
c) What kind of business strategy do the e-Book-reader companies have?
d) What must be considered in a comprehensive business strategy when approaching the BOP?

To achieve this objective the author has structured the analysis in three main steps:

1) A country analysis, focusing on the opportunities and threats in BOP markets in order to identify the most favourable countries for a market-entry. For the country analysis a point scoring system considering the PEST framework has been devised (cp. chapter 2.1.)
2) An industry analysis in order to understand the main competitive forces within the industry. For this analysis Porter’s five forces model has been applied (cp. chapter 2.2.).
3) A business strategy analysis in order to analyse the strengths and weaknesses of the main competitors that have been identified within the industry analyses. A questionnaire has been send to the headquarters of four companies in order to gather additional information, but the companies did not respond or declared that they are not allowed to provide any information on this topic (For the questionnaire please refer to ANNEX II). Therefore the different strategies have been analysed according to Porters “competitive advantage” (cp. chapter 2.3.).

Based on these steps the main strategies are summarised to conquer the constraints of BOP markets. International recommendations based on the BOP approach are considered to conclude with a final strategy map for the eBook-reader industry.

Before starting the analyses, the following two sub-chapters explain the BOP approach and introduce the eBook-reader.

1.3 How to approach the “base of the pyramids”

For the last 60 years a number of strategies have been applied by different multilateral, as well as different bilateral (non-) governmental organisations. The basic needs approach supports government and aid intervention programs to address shortages by increasing purchasing power (Sachs, 2005). The empowerment and participation approach focuses on liberation from local sources of exploitation by empowering local actors to change their situation (Sen, 2004). The New Common approach supports an ongoing creative dialogue across differences to enable new forms of human organisation while increasing mutual respect and understanding (cp. Simanis et al. 2008, p. 60).

However, in general the poverty penalty remained very high. Reasons for this situation are monopolistic business structures, weak infrastructure, corrupt governments, low sales volume due to fragmented purchasing power and limited access to credits.

To change the focus from further “help” and “development-aid support” to a more “business-orientated thinking”, Prahalad developed the “Base of the Pyramid” approach (2005). Prahalad assumes that the combined yearly purchasing power of about 4 billion people at the bottom of the pyramid sums up to five trillion US$. Figure 1 (next page) shows the global income (pyramid) distribution of the four billion people living with less than 3,000$ in local purchasing power per year in six different segments. The biggest group lives from 1,000 to 1,500 $ per year.

Prahald concludes that by targeting this untapped purchasing power, Multinational Enterprises (MNE) can make significant profits as well as help to reduce poverty.

Based on a number of case studies Prahalad and others have shown that the cooperation between different stakeholders and the introduction of innovative technologies and business concepts can reduce the poverty penalty. For example, the availability of affordable mobile telecommunication has enabled low-income families in many BOP-markets to start or improve their own business.

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According to Hammond et al. 2007, p.13

Figure 1: 5 trillion $ - Income distribution in BOP segments^[4]

Many BOP markets could leapfrog standard technologies (e.g. fixed telephone lines) by applying alternative technologies (e.g. mobile phones) and innovative business models (e.g. based on SMS services etc.) much faster than developed markets. Figure 2 shows the growth of mobile cellular subscriptions compared to fixed telephone lines between 1990 and 2007. It highlights the leapfrogging potential of mobile technologies.

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According to: UN, 2009, p. 51

Figure 2: Usage of different communication technologies in developing regions

One significant aspect of the Base of the pyramid (BOP) approach is that people living in these segments are now perceived as creative entrepreneurs and customers, especially when they are linked to (multi-national) enterprises, non-governmental organisations and local governments. The BOP is seen as a huge and under-served market that can be approached by new business endeavours. Key for success is the creation of win-win situations by making use of innovations, creating new business models and local and multi-national partnerships. Most successful examples for such win-win situations are based on innovations such as mobile phones, the Internet and micro credits.

Following Prahalad’s approach, the generation of profits is possible at the BOP^[5]. This approach might attract and enable Multi National Enterprises (MNE) to invest in those low-income markets. However, the approach to reduce retail prices and therefore the margins aiming at increasing the purchasing power of the poor is new to most MNE.

Hammond (cp. Hammond et al. 2007) describes markets consisting of people with a yearly income between 3,000 and 20,000 $ as already developed. In contrast the market of the very poor (below 3,000 $) seems unattractive at first sight, as spending for food dominates a typical BOP household budget. However, as soon as incomes rise, “the share spent on food declines, while the share for housing remains relatively constant - and the share for transportation and telecommunications grows rapidly” (Hammond et al, p.14). Prahalad describes a number of BOP business innovations that have successfully contributed to meeting local needs. These business innovations need to be designed in a certain way, if they are going to become economical sustainable and support local development. One of his main recommendations how to develop such innovative business models is to pool different stakeholders with different levels of experience and knowledge and support a structured dialogue between them. His approach opened a broad international discussion on how to create such business models for the base of the pyramid.

Some authors such as Karnani criticise that it is not enough to look for innovative business strategies for MNE to serve these markets: “the only way to alleviate poverty is to raise the real income of the poor” (Karnani, 2006, p.4). Therefore MNE should rather buy something from the poor instead of selling something. Another neglected aspect in the BOP approach is that institutions dealing with consumer protection are often too weak or not in place. This can become a threat for poor consumers, as wrong product decisions have a much bigger impact on their life as for richer and better-educated people (Karnani, 2006, p. 16). The term “BOP-market” can also have a negative impact on companies, when they look at it as one homogeneous market and therefore fail when approaching it. “In fact, it is not a market at all. The BOP is a demographic classification” (Simanis et al. 2008, p. 58). For this reasons Simanis et al. extended the first BOP approach and described the wider approach in the BOP protocol 2.0. (Please refer to Table 1). In order to approach BOP markets companies and their managers should get a better understanding how these markets function, and apply a new set of managerial tools, as is described in the BOP protocol 2.0 (cp. Simanis and Hart, 2008). The protocol highlights the need to combine value creation by enterprises with the demands of the poor. The development of the BOP protocol 2.0 is based on experiences gained in so called learning labs, a worldwide network lead by Stuart Hart, consisting of researchers, entrepreneurs and Non-Government-Organisations (NGO) aiming at finding potentials or hidden assets of poor communities and developing innovative BOP business models.

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According to Simanis et al. (2008, p.2)

Table 1: Development of the BOP Strategy

Based on Prahalad’s assumption on the purchasing power at the Base of the Pyramid, the BOP 2 Protocol provides a framework that supports the creation of sustainable and successful businesses. It uses confidence-building methods such as participatory rural appraisal, rapid assessment process and empathy-based design (cp. Simanis, p.3) and follows three phases:

- Engage in deep listening and mutual dialogue with income-poor communities.
- Co-discover and co-create new business opportunities and business models embedded in the local cultural infrastructure.
- Co-design and launch BOP businesses that generate mutual value for all partners.

Hart (2005) assumes that the confidence-building processes necessary for investments in new markets and products can take between 3 to 10 years. The question remains if MNEs will be able to persevere such long periods before realising a return on investment. However, as many of their businesses in developed countries are shrinking due to saturated markets and demographic factors, approaching the BOP might become a viable option. Further, product and business development aimed at “poor” markets can bring forth so called “disruptive technologies“, innovations that might enter developed markets also (cp. Simanis, 2008; Hart, 2005)^[6].

1.4 The product - eBook-reader

In recent years Information and Communication Technologies became more important, also for most developing countries. Background for this development is that with the emergence of better ICT-infrastructure, affordable digital and mobile devices and transferable digital content transaction costs have sharply decreased.

According to Leff (1984) ICTs contribute to an overall increase in the amount of information that can be faster transmitted, searched and processed. This leads to a reduction of time and monetary costs for transmitting information, immediate inter-

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To get a better understanding of the “eBook-reader” product, three key elements that make up an e-Book-reader will be defined (Figure 4):

- eBook-reader device
- eBook-portals, includes eServices
- eBooks^[7]

By considering these key elements the industry and competitor analysis can be focused on a few companies only.

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Figure 4: e-book reader – key elements

- eBook-reader device: The eBook-reader device is a piece of hardware that enables the reading of eBooks. The main innovation is its display technology that is based on electronic ink (E-Ink), sometimes also referred to as electronic paper (E-Paper). Compared to conventional LCD-displays E-Ink is rather thin and flexible (please see figure 5), and in usage its energy consumption is much lower. It enables a very comfortable reading, even in bright sunlight and from different angles that can compete with ordinary books.

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According to Behrendt et al. 2008, p.166

Figure 5: E-Ink compared to LCD-Display technology

The hardware comes together with some supporting software that can transfer different eBook formats to the needed output format. Most eBook-reader devices can show different letter sizes, so that people with sight impediments or elderly people can also read an eBook. Another software innovation is the ability to create audio output, so that even illiterate or people with sight disabilities so grave they cannot read can listen to an eBook.

- eBooks: A pre-installed library of eBooks with relevant content and language for the BOP target reader group is a unique selling point. For example, if such a device is introduced as an educational tool for students e.g. for secondary education, it must contain all obligatory textbooks for secondary education in an eBook format. Also eBooks that are relevant for secondary education but are not compulsory can be added to increase the value for the target group. As the target group often does not have access to affordable Internet connections it is very important to add relevant eBooks to the eBook-reader before its distribution to BOP markets (please see country selection analysis).

In general eBooks can be read on all kinds of devices, but unfortunately there is a wide range of formats available and not all of them are readable on all devices. Currently the most common standard used is PDF. However, as PDF is always using a standard and fixed size, it is very difficult to read it on small displays that are normally used in mobile phones. The industry has developed a number of other standards that can easily break texts in different display sizes. Some of these formats are proprietary and can be read only on few devices, others are open and can be read on nearly all kind of devices. Currently it is not clear which will become the leading standard for eBook-reader. One of these standards that could become the new industry standard is the EPUB standard, as it is based on XML and defined by the Open eBook Forum of the International Digital Publishing Forum (International Digital Publishing Forum, 2009).

The production of eBooks is cheaper than paper based products and therefore can be offered at a much lower price compared to printed textbooks. In a recent press release the publisher “Flat World Knowledge”, announced that based on a trial during spring 2009, they are able to reduce “average textbook costs to only $18 per student per class, an 82% cost reduction compared to traditional printed textbooks averaging $100 per student per class” (Flat World Knowledge, 2009).

- eServices / eBook-portals: From a business perspective, the most important part of the eBook-reader is a channel for the distribution of additional eBooks and supporting services (eServices). In general this is the eBook-portal, a web-based portal where the users of eBook-readers can purchase new eBooks and applications that match their interests. A good eBook-portal can be an alternative to brick and mortar stores and open a market as long as the operating company knows how to bring publishers and authors (supplier) and consumers together. The companies’ ability of orchestrating as many content suppliers (and active customers) via the Internet as possible can create a competitive advantage and bind customers to its products, something that has been described in detail by Tapscott and Williams (2007). Alternatively eBook-portals can establish a niche market and offer specialised eBooks. However, with respect to BOP markets, companies have to think about additional offline channels for the distribution of eBooks.

With the explosion of digital content available in many different eBook formats, the emergence of different eBook-reader devices and the increasing accessibility of online content, the publishing industry is challenged as never before. The impact might be similar to the one mp3s and the iPod have had on the music industry. The big difference is – based on the experiences in the music industry – the publishers know the digital challenge and therefore can adapt their strategies to participate in this business new reality.

The new technologies and business strategies might offer a huge opportunity for people living in emerging and developing countries – even at the base of the pyramid. Currently many of them can neither access nor afford books. With affordable eBooks and eBook-readers, at least students should be able to access and afford much more books than today. Even illiterate people might benefit from access to eBook-reader when supplied with appropriate applications.

2 ANALYSIS

2.1 Country analysis

The objective of the country analysis is to identify those BOP countries offering the most favourable conditions for a market entry for companies that want to introduce an e-Book-Reader. Companies need to know all possible opportunities and incentives, as well as all threads and barriers.

BOP markets are not homogeneous and companies have to be careful not to overestimate the purchasing power of poor people. Its customers are culturally different and often live dispersed and in geographically heterogeneous areas. In addition the necessary infrastructure is often weak or even not in place, and most business transactions are small in size. All this “increases distribution and marketing costs and makes it difficult to exploit economies of scale” (Karnani, 2006, p.6). Based on the following country analysis, a first country ranking will show which countries might offer the best environments for a market entry. A following and concluding evaluation highlights all potential opportunities and strengths in selected BOP countries. This information might help to decide in which markets to invest and how to adopt product and business models to the respective market environments.

[...]

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^[1] This and all following data that refer to BOP income have been measured in 2002 international dollars (purchasing power parity dollars or PPP), since 2002 is the reference year to which the BOP data were normalised (Hammond et. al., 2007, p.1).

^[2] For example the organisations’ website (one laptop per child, 2009) contains much information about the idea, technology, the software programs and the potential children using it, but nearly nothing on how to implement it at school level.

^[3] First eBook-reader trials have already been started more than 10 years ago, one reason why some experts do not believe in a market success. However, in a video Paul Saffo explains why technologies takes time – often 20 years – to move from invention to adoption and that this could be a reason why the long-term impact of the eBook-reader is still under-estimated: http://www.youtube.com/watch?v=7vWFoPqzSd0

^[4] Sources of figures and tables in this thesis are classified as:

„According to“ if the cited document does already contain a figure or table similar to the one produced;

Data Source if the data from the source was used to design a table or figure;
If no source is indicated, data as well as design of table or figure is based on own data and concepts

^[5] Also nobel prize laureate Muhammed Yunus allowed profit generation within his concept of „Social Business“, he did not focus on creating profits. In his concept the generated return of investment is in general used to benefit poor people and therefore reinvested.

^[6] e.g. in a video interview (http://www.viddler.com/explore/Mediabistro/videos/349/93.143/) publishing consultant Rüdiger Wischenbart explains how American publishers could benefit from new subscription models in China.

^[7] Electronic Books, similar terms used in the literature: e-Books, ebooks