What is the Role of Profit in Scaling Social Impact?

featuring Michael Chu

january 17, 2013

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WEBINARS
january 17, 2013

What is the Role of Profit in Scaling Social Impact?

OVERVIEW
Most of the world is poor, without access to healthcare, clean water, housing, and other fundamental services that enable individuals to flourish. But governments and development agencies are ill-equipped to deliver the scale, sustainability, and constantly improving efficacy and efficiency that social change demands. Only private enterprise, in the form of competitive industries searching for profit, has the staying power and incentive to serve customers at the bottom of the economic pyramidand to change their lives.

CONTRIbuTORs
Michael Chu Managing Director, IGNIA Fund, and Senior Lecturer, Harvard Business School Angelia Herrin (Moderator) Editor for Special Projects and Research, Harvard Business Review

CONTEXT
Michael Chu, a leading microfinance investor who researches and writes about scaling social impact, discussed the business opportunity in providing basic goods and services to the worlds poor. Through multiple case studies in areas such as healthcare, water supply, and microfinance he described how private enterprises can serve both commercial and social goals.

KEy lEaRNINgs
The majority of the worlds population is poor and unable to realize its potential due to lack of access to basic services. Despite economic advances in developing countries, four billion peopleor 60% of humanitystill earn less than $3,000 a year (Figure 1). Those at the top of at the income pyramid generally have access to housing, healthcare, education, financial services, personal security, and basic services such as power and clean water. This access enables people to express the full potential of their intellect and spirit. By the same token, those at the base of the pyramid, lacking that access and inclusion, cannot realize their full potential.
Figure 1 World income pyramid

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What is the Role of Profit in Scaling Social Impact?

january 13, 2013

At the base of the income pyramid, most consumer activity is cash-in-hand. These private marketplaces are growing. The issues at the bottom of the income pyramid are so fundamental that most people assume that only government and charitable, non-governmental organizations (NGOs) can address the inequity, through social programs and income redistribution. However, in the worlds poorer countries, most economic activity takes place outside the public sector, in the private or informal marketplace. In India, for example, 80% of healthcare spending is out of pocket and not public health expenditures. There are active, daily markets that: 1) compete on the basis of supply, demand, and price; and 2) generate a sustainable surplus of revenues over costs (i.e., profit). This is doing business by anyones definition. How large is this hidden market? Conservative estimates put the turnover figure at $5 trillion purchasing-parity dollarsand this market is growing faster than the developed world. Therein lies the opportunity for commercial enterprises: providing basic services to emerging consumers who are already familiar with a free-market environment. Measuring successful social impact requires careful definition and an extended timeframe. Profit is easy to measure; social impact is not. Commercial returns are a straightforward function of costs, pricing, and asset leverage, and returns on equity can increase as prices fall, as long as costs drop faster and/or assets are used more efficiently. Social value, on the other hand, must be measured in relation to the entire target population those served plus those who remain unservedas well as its future impact. As the case studies demonstrate, however, profit and social value are not necessarily in conflict; high financial returns can co-exist with the creation of significant social value. The acronym BEST attempts to reconcile the inherent tension between private enterprise and transformational social change: Best: The most effective, accessible option. Economical: At the lowest price for the end user. Solidarity: For all those who need it. Today: As urgently as possible. To achieve BEST, organizations need S2E2: scale, sustainability, efficacy, and efficiency, which businesses are far better structured to provide than NGOs, philanthropists, development agencies, or governments.

by and large, what to do is known and simple. The challenge is to make it available to the majority of the world.
Michael chu

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What is the Role of Profit in Scaling Social Impact?

january 13, 2013

No single business can take on the social challenge; only entire industriesgroups of competing businessesare robust enough to deliver the S2E2 that ultimately creates access for all within a society. And these industries coalesce only when a commercial activity provides above-average returns. This is how profits and industries serve a social role. For example, competition among Latin American microfinance lenders has driven down interest rates, benefiting borrowers at the base of the pyramid.

case Study 1: Farmacias Similares thrives by providing generic medicines and efficient clinical care to low-income Mexicans.
In a country where the bottom three income tiers comprise 85% of the population, the government provides free healthcare for everyone. In reality, however, long wait times consume days and bare shelves in public health pharmacies82% of the timeforce patients to obtain their medicines in traditional, full-price pharmacies. Moreover, Mexico has the highest drug prices in Latin America. In 1997, with $2 million in seed capital, entrepreneur Victor Gonzlez Torres introduced a new, two-pronged business model targeted at this market: 1. Low-priced generics. Farmacias Similares stocks only generic medicines and sells them for 3075% less than patent-protected drugs. Previously, the generics manufacturers sold only to the public health system. 2. Attached clinics. Next door to most Farmacias Similares stores is a medical clinic, nominally operated by a private foundation. The wait to see a doctor is typically 15 minutes, and the consultation costs the equivalent of $2. The doctors have the same training as those in the public health system, and actually earn more. Farmacias Similares also employs clever marketing approaches, such as its mascot, Dr. Simi, who appears outside stores at noontime, and a bevy of Simi Chicas (girls), who promote low-cost, high-quality Simicondoms. Today, the company has almost 4,000 stores, with 12 million monthly pharmacy clients and 3.5 million clinic visits. Sales are over $1 billion, and the company is solidly profitable. In terms of impact, this business contributes an estimated $800 million of annual value to the bottom three tiers of the Mexican population pyramid, half in the form of lower drug prices, and half by way of more productive use of customers time compared with public health clinics.

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What is the Role of Profit in Scaling Social Impact?

january 13, 2013

case Study 2: Manila Water makes clean water available to 98% of the city population.
The Philippines capitals municipal government was unable to provide a safe water supply to most residents. In fact, the subsidized water principally benefited high-income neighborhoods. In poor neighborhoods without connections, residents paid seven times as much for bottled water. In 1999, the city privatized its water service, assigning the concession for the eastern half of the city to newly formed Manila Water, led by Grupo Ayala with technology partners in the United States and the United Kingdom. (Western Manila was assigned to another multinational group that failed and left.) During its first year, due to theft and broken pipes, the company was able to invoice only 37% of the water it supplied, and the enterprise lost $1 million. However, Manila Water began to invest in infrastructure, spending $475 million to upgrade almost 1,900 kilometers of pipefully one-third of the system. Over the next six years, Manila Water doubled the number of sewer connections and boosted the customer base from 325,000 households to 909,000, serving more than five million residents. 24-hour access to water rose from 28 to 98% of the population, and water quality reached 100% compliance with national standards. In 2006, the firm was able to invoice 70% of the water supplied, and its net profit rose to $49 million. When it went before regulatory authorities for permission to raise rates, community groups turned out in force to support the application. Again, a private company scaled up an essential service for very low-income consumers, had a positive impact on society, and made a profit in the process.

When this type of model succeeds, after a lot of hard work, it can be fantastic, both socially and as a business.
Michael chu

case Study 3: compartamos Banco grows by making tiny loans to groups of rural women.
In Mexicos poorest states, Chiapas and Oaxaca, a group of university students started a poverty-oriented NGO in 1990. In 2000, a group of non-profits turned the NGO into Compartamos (Lets Share), a regulated financial institution focused exclusively on microfinance loans. After bond issues, regulators approved a full banking license in 2006, converting the organization into Compartamos Banco. Operating mainly in rural areas throughout the country (only 3% of lending is urban), bank loan officers make loans to groups of 1280 women, with whom they meet weekly. The group appoints its own treasurer, who is responsible for collecting payments and depositing funds. By 2011, four years after the banks successful IPO, which raised $1.5 billion, the company had expanded operations to Peru and Guatemala. It now has about 2.6 million active clients who have an average loan balance under $500. The bank has lent $1.2 billion and has an outstanding return on equity of 35%.

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What is the Role of Profit in Scaling Social Impact?

january 17, 2013

bIOgRaPHIEs
Michael Chu Senior Lecturer of Business Administration , Harvard Business School Angelia Herrin (Moderator) Editor for Research and Special Projects, Harvard Business Review

Michael Chu was appointed a Senior Lecturer in the Initiative on Social Enterprise of the General Management Group of the Harvard Business School in July 2003. He is also Managing Director of the IGNIA Fund, an investment firm based in Monterrey, Mexico, dedicated to investing in commercial enterprises serving low-income populations in Latin America, which he co-founded in 2007. He continues to serve as Senior Advisor and a founding partner of Pegasus Capital, a private equity firm in Buenos Aires, with a portfolio which includes major companies and real estate developments in Argentina, and a real estate joint venture in Colombia. Chu is also a co-head of Project Antares, a collaboration between HBS and the Harvard School of Public Health focusing on commercial approaches to deliver high-impact primary health care to low-income populations in developing nations. Before Pegasus, as President and CEO of ACCION International, a nonprofit microfinance pioneer, Chu worked to develop financial services for low income sectors as a new segment of banking capable of outstanding returns. He participated in the founding of several regulated microfinance institutions and banks throughout Latin America, including Banco Solidario which under his chairmanship has been the most profitable bank in Bolivia, Mibanco in Peru and Compartamos

Banco, which following its IPO in the Mexican Stock Exchange in 2007 has been incorporated into that exchanges index. From 1989 to 1993, as an executive and limited partner in the New York office of Kohlberg Kravis Roberts & Co, Chu was one of sixteen professionals deploying KKRs $5.7 billion private equity fund and managing an investment portfolio with aggregate annual revenues in excess of $60 billion. He joined the private equity firm from PACE Industries, a KKRsponsored leveraged buyout, where he served as Senior Vice President & CFO. Previously, he held senior management positions in U.S. corporations and was a management consultant with the Boston Consulting Group. Chu currently serves on the boards of Arcos Dorados (NYSE), Sealed Air Corporation (NYSE), and is an Emeritus Director of ACCION International and a Trustee Emeritus of Dartmouth College. Chu graduated with an AB (Honors) from Dartmouth College and received a MBA with highest distinction (Baker Scholar) from Harvard Business School.

Angelia Herrin is Editor for Research and Special Projects at Harvard Business Review. At Harvard Business Review, Herrin oversaw the re-launch of the management newsletter line and established the conference and virtual seminar division for Harvard Business Review. More recently, she created a new series to deliver customized programs and products to organizations and associations. Prior to coming to Harvard Business Review, Herrin was the vice president for content at womenConnect.com, a website focused on women business owners and executives. Herrins journalism experience spans twenty years, primarily with KnightRidder newspapers and USA Today. At Knight- Ridder, she covered Congress, as well as the 1988 presidential elections. At USA Today, she worked as Washington editor, heading the 1996 election coverage. She won the John S. Knight Fellowship in Professional Journalism at Stanford University in 198990.

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2013 Harvard Business School Publishing. Created for Harvard Business Review by BullsEye Resources www.bullseyeresources.com

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