Value Innovation for the Bottom of the Pyramid: profitability pursuing superior value and low cost in emerging markets (really)

By Bernardo Sichel
Director of Consulting, DSI

One of the most intriguing and potentially profitable applications of Value Innovation lies in emerging markets. This framework could provide the missing link between the concepts around the “Bottom of the Pyramid” and its real life applications. By forcing companies to decide what competitive factors they need to add, raise, reduce, and eliminate, Value Innovation offers companies the ability to deliver superior value at accessible price points for low-income consumers around the world.

Background

Professor C.K. Prahalad and other prominent authors introduced the concept of the “Bottom of the Pyramid” (BOP) in the late 1990s¹. At the highest level, the BOP represents the bottom tier of the world economic pyramid; a consumer group of more than 4 billion people with an annual income below $1,500 per year living in the developing world. Prahalad and his colleagues suggest that this market represents both an attractive prospect for the multinational companies and an opportunity for prosperity and development for the aspiring poor.

The following statistics provide some additional information on the size of the opportunity for multinational companies²:

• China, India, Brazil, Mexico, Russia, Indonesia, Turkey, South Africa and Thailand are home to about 3 billion people (70% of the developing world).
• The combined purchasing power parity GDP of these countries is $12.5 trillion (90% of the developing world); this is larger than the GDP of Japan, Germany, France, the United Kingdom, and Italy combined.

Over the past decades, multinational companies from various sectors, ranging from consumer products to pharmaceuticals and from computers to automobiles, have made modest progress penetrating developing markets. Multinationals traditionally targeted middle and upper class individuals in emerging markets; those consumers who value western style products and who are willing to pay for their premium prices. By doing so, those companies have literally excluded more than 60% - 70% of the population in the developing world. Secondly, and arguably the most important, multinationals have been unsuccessful at applying the BOP principles. Despite many multinationals embracing the concepts, there is still little to show for in terms of results. In this regard, a huge chasm still exists between theory and practice.

Some companies have been able to get it right. Hindustan Lever in India (e.g. Wheel detergent, Lifebuoy soap), Procter & Gamble in China (e.g. Jasmine Tea Crest), Cemex in Mexico (i.e. Patrimonio Hoy program), and Casa Bahía in Brazil (i.e. electronic, appliance and furniture stores) provide some examples³. These companies successfully apply the principles of the BOP. Their products and services have been developed from the bottom-up to meet predetermined price points while fulfilling the demands of brand and value conscious consumers. Moreover, they have combined local market insights with effective resource deployment (e.g. alternative go-to-market strategies, flexible manufacturing) to achieve the necessary scale and low-cost operations that ultimately make their ventures sustainable and profitable (through volume and not gross margins).

But even these companies do not have a secret formula. Despite the great advances of companies like Procter & Gamble in developing countries, these markets still represent a relatively low percentage of their total revenues and profits⁴. Furthermore, most BOP experts continue to use analogies to explain the success and best practices of leading companies. The “what” is clear, but the “how” is still some kind of alchemy. There is a clear need for a tool kit to tap into the BOP and improve the success rates of multinational companies interested in serving this attractive market.

Enter Value Innovation

In their bestselling book “Blue Ocean Strategy: How to Create Uncontested Market Space and Make Competition Irrelevant” (Harvard Business School Press, 2005) authors Chan Kim and Renée Mauborgne propose the concept of Value Innovation. In a nutshell, Value Innovation is about achieving a quantum leap in buyer power while pushing for a sharp drop in the industry’s cost structure⁵.

The simultaneous pursuit of radically superior value and low cost is achieved by recombining the industry’s competitive factors and searching for new ones from outside sources. The objective is to enhance differentiation by raising some factors well above the industry standard and creating additional factors the industry has never offered, while reducing cost by eliminating some standards the industry takes for granted and reducing other factors below industry average (see Figure 1).

Figure 1 – The Value Innovation Concept

An example will help explain Value Innovation in practice.

The Yellow Tail Story

In the late 1990s, the US wine industry was burdened by intense competition (more than 60,000 new wine labels every year) and consolidation at the producer (top 8 companies controlled more than 75% of the volume) and distribution stages (number of distributors declined by over 75% since the 1960s) of the value chain. Under these circumstances, Casella Wines, a small family-owned Australian winery, decided to enter the US market in 2000.

Casella’s first product, Yellow Tail [YT], displayed no characteristics of traditional wine. Before the introduction of [YT], wine catered to the informed consumer. These “wine connoisseurs” desired a wide range of products to suit their palettes and often best targeted through marketing and brand building brimming of enological jargon. They concerned themselves with tannins, acidity, oak, yeast, complexity, and aging.

[YT] took a different approach and instead of marketing to the traditional wine consumer, chose to pursue people who normally do not drink wine. At the time, Casella offered only one white and one red wine, each marked with a unique and eye-catching kangaroo logo. No technical wine speak or a complex selection of varying wine types to confuse their target audience, only the logo to attract their consumers. Furthermore, beer and cocktail drinkers found themselves attracted to the uniquely soft, sweet, and fruity taste of the new wine.

The results have been outstanding. In 2004, Casella sold more than 11.2 cases of [YT] in the US alone, becoming the fastest growing brand in the history of the US and the Australian wine markets. In the process, [YT] has become the number one imported wine in the US, and the [YT] merlot is the overall top-selling merlot in the country.

So how did they do it? While the US market was highly competitive, only one in four consumers drank wine and per capita consumption was at 1.5 gallons (vs. 61 gallons for the French). By focusing in non-drinkers (a much larger potential market than the existing one) and offering an alternative value curve (see Figure 2), Casella was able to achieve Value Innovation and capture a “Blue Ocean”.

Figure 2 – Yellow Tail Strategy Canvas

Note the choices made by Casella to enter the US market:

• They focused on non-consumers rather than current wine drinkers.
• They raised the price versus budget wines and also the retail store involvement.
• They created new competitive factors around easy drinking, ease of selection, and fun and adventure.
• They eliminated enological terminology and distinctions, aging qualities and above-the-line marketing.
• They reduced wine complexity, wine range, and vineyard prestige.

So what have been the financial results? Casella has truly achieved Value Innovation with its [YT] offering: estimated profits for 2003 were $41 million on sales of over $227 million (18% margin).

Potential Applications

The traditional way of doing business in emerging markets either focuses on the upper classes or offers strip down products to low-income consumers. Neither of these approaches successfully taps into the potential of emerging markets.

Value Innovation offers a framework to map out potential offerings and to decide which competitive factors to add, raise, reduce, and eliminate. It is a framework to harness the concepts of the BOP to secure achieving customization while the virtuous cycle of value pricing, scale and low-cost operations is realized.

Revisiting a widely known example will help explain the potential application of Value Innovation for the BOP⁶.

The Wheel story revisited

Hindustan Lever Ltd (HLL) was the leader of the Indian detergent market until 1990. Despite a tradition of several decades in the country, the company mainly served the elite that could pay for western style products. In 1990, however, a local company called Nirma introduced a detergent for low income consumers, especially those in rural areas. This company created a low cost business model (low cost formula and manufacturing) that offered a reformulated product, in small sizes, and available through a wide array of retail channels. It was an immediate success.

After losing market share for 5 straight years with its high-end products, HHL decided to respond to Nirma’s challenge by launching “Wheel”. By 1999, HLL had recuperated its market position and achieved sales of $100 million with its new detergent. Furthermore, despite gross margins of 18% (vs. 25% for high-end products), the company achieved a return on capital employed (ROCE) of 93%, 4X higher than with its high-end products.

The success of “Wheel” has been well documented. The company set out to create not only a new product, but a novel business model to serve the BOP in India. It started with a price point and consumer requirements and worked its way backwards (instead of just stripping down features on current offerings). This is how, for example, the formulation included a low oil to water ratio to account for the fact that the poor often wash their clothes in rivers and other public water systems. HLL also decentralized production, marketing, and distribution of the product to leverage the abundant labor pool in India.

Particularly interesting were the creation of the Bharat door-to-door program and the use of focused promotion and advertising activities at the village level. In the case of the former, the entrepreneurial program significantly increased coverage in rural areas while helping local women set-up a sustainable business. In the case of the latter, the focused promotion (e.g. Operation Harvest, Cinema Vans and Fairs) made up for the absence of traditional media and increased the loyalty through personal experience and bonding of the consumer with the brand.

We can use the Value Innovation framework to understand some of the choices involved in the launch of “Wheel” (see Figure 3):

• Wheel also searched for non-traditional consumers as its target market. As a result, the overall detergent business in India expanded.
• Wheel significantly decreased the price, performance (stain removal), and packaging attractiveness.
• Wheel eliminated mass media, the urban focus (washing machine), and modern outlet distribution.
• Wheel in turn was able to significantly increase the product and packaging robustness to withstand the hardships of the Indian supply chain and long expected shelf life.
• Wheel also was able to add a customized formulation for hand-wash in rivers (leveraging an emotional appeal), door-to-door selling (similar to Avon in the cosmetic industry) along with hundreds of thousands of small retail outlets, and localized promotion and advertising (similar to the circus industry).
• Wheel’s regional low-cost manufacturing was also another aspect of the low level of resource intensity and successful financial results.

Figure 3 – Wheel Strategy Canvas

Takeaway

The BOP represents a huge untapped opportunity for multinational companies searching for growth opportunities. For many years, shrewd managers have embraced the BOP concepts without much to show for. Not anymore. Value Innovation provides the right framework and tools to help managers conceptualize new products and business models that combine the required customer value and low costs to achieve success in emerging markets.

If you would like to further explore this subject, please refer to our website (www.thinkdsi.com) or contact Bernardo Sichel at sichel@thinkdsi.com and/or (610) 717-1000 ext 122.