Understanding Corporate Social Responsibility Excrepts from HBR Article by C.K Prahlad

Understanding Corporate Social Responsibility

Excrepts from HBR Article by C.K Prahlad

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By stimulating commerce and development at the bottom of the economic pyramid, multinationals could radically improve the lives of billions of people and help create a more stable, less dangerous world. Achieving this goal does not require MNCs to spearhead global social-development initiatives for charitable purposes. They need only act in their own self-interest. How? The authors lay out the business case for entering the world's poorest markets.

Fully 65% of the world's population earns less than $2,000 per year-that's 4 billion people. But despite the vastness of this market, it remains largely untapped. The reluctance to invest is easy to understand, but it is, by and large, based on outdated assumptions of the developing world.

While individual incomes may be low, the aggregate buying power of poor communities is actually quite large, representing a substantial market in many countries for what some might consider luxury goods like satellite television and phone services. Prices, and margins, are often much higher in poor neighborhoods than in their middle-class counterparts. And new technologies are already steadily reducing the effects of corruption, illiteracy, inadequate infrastructure, and other such barriers.

Because these markets are in the earliest stages of economic development, revenue growth for multinationals entering them can be extremely rapid. MNCs can also lower costs, not only through low-cost labor but by transferring operating efficiencies and innovations developed to serve their existing operations.

Certainly, succeeding in such markets requires MNCs to think creatively. The biggest change, though, has to come from executives: Unless business leaders confront their own preconceptions—particularly about the value of high-volume, low-margin businesses—companies are unlikely to master the challenges or reap the rewards of these developing markets.

Consider this bleak vision of the world 15 years from now: The global economy recovers from its current stagnation but growth remains anemic. Deflation continues to threaten, the gap between rich and poor keeps widening, and incidents of economic chaos, governmental collapse, and civil war plague developing regions. Terrorism remains a constant threat, diverting significant public and private resources to security concerns. Opposition to the global market system intensifies. Multinational companies find it difficult to expand, and many become risk averse, slowing investment and pulling back from emerging markets.

Now consider this much brighter scenario: Driven by private investment and widespread entrepreneurial activity, the economies of developing regions grow vigorously, creating jobs and wealth and bringing hundreds of millions of new consumers into the global marketplace every year. China, India, Brazil, and, gradually, South Africa become new engines of global economic growth, promoting prosperity around the world. The resulting decrease in poverty produces a range of social benefits, helping to stabilize many developing regions and reduce civil and cross-border conflicts. The threat of terrorism and war recedes. Multinational companies expand rapidly in an era of intense innovation and competition.

Both of these scenarios are possible. Which one comes to pass will be determined primarily by one factor: the willingness of big, multinational companies to enter and invest in the world's poorest markets. By stimulating commerce and development at the bottom of the economic pyramid, MNCs could radically improve the lives of billions of people and help bring into being a more stable, less dangerous world. Achieving this goal does not require multinationals to spearhead global social development initiatives for charitable purposes. They need only act in their own self-interest, for there are enormous business benefits to be gained by entering developing markets. In fact, many innovative companies—entrepreneurial outfits and large, established enterprises alike—are already serving the world's poor in ways that generate strong revenues, lead to greater operating efficiencies, and uncover new sources of innovation. For these companies—and those that follow their lead—building businesses aimed at the bottom of the pyramid promises to provide important competitive advantages as the twenty-first century unfolds.

Big companies are not going to solve the economic ills of developing countries by themselves, of course. It will also take targeted financial aid from the developed world and improvements in the governance of the developing nations themselves. But it's clear to us that prosperity can come to the poorest regions only through the direct and sustained involvement of multinational companies. And it's equally clear that the multinationals can enhance their own prosperity in the process.

Everyone knows that the world's poor are distressingly plentiful. Fully 65% of the world's population earns less than $2,000 each per year—that's 4 billion people. But despite the vastness of this market, it remains largely untapped by multinational companies. The reluctance to invest is easy to understand. Companies assume that people with such low incomes have little to spend on goods and services and that what they do spend goes to basic needs like food and shelter. They also assume that various barriers to commerce—corruption, illiteracy, inadequate infrastructure, currency fluctuations, bureaucratic red tape—make it impossible to do business profitably in these regions.

But such assumptions reflect a narrow and largely outdated view of the developing world. The fact is, many multinationals already successfully do business in developing countries (although most currently focus on selling to the small upper-middle-class segments of these markets), and their experience shows that the barriers to commerce—although real—are much lower than is typically thought. Moreover, several positive trends in developing countries—from political reform, to a growing openness to investment, to the development of low-cost wireless communication networks—are reducing the barriers further while also providing businesses with greater access to even the poorest city slums and rural areas. Indeed, once the misperceptions are wiped away, the enormous economic potential that lies at the bottom of the pyramid becomes clear.

Take the assumption that the poor have no money. It sounds obvious on the surface, but it's wrong. While individual incomes may be low, the aggregate buying power of poor communities is actually quite large. The average per capita income of villagers in rural Bangladesh, for instance, is less than $200 per year, but as a group they are avid consumers of telecommunications services. Grameen Telecom's village phones, which are owned by a single entrepreneur but used by the entire community, generate an average revenue of roughly $90 a month—and as much as $1,000 a month in some large villages. Customers of these village phones, who pay cash for each use, spend an average of 7% of their income on phone services—a far higher percentage than consumers in traditional markets do.

It's also incorrect to assume that the poor are too concerned with fulfilling their basic needs to "waste" money on nonessential goods. In fact, the poor often do buy "luxury" items. In the Mumbai shantytown of Dharavi, for example, 85% of households own a television set, 75% own a pressure cooker and a mixer, 56% own a gas stove, and 21% have telephones. That's because buying a house in Mumbai, for most people at the bottom of the pyramid, is not a realistic option. Neither is getting access to running water. They accept that reality, and rather than saving for a rainy day, they spend their income on things they can get now that improve the quality of their lives.

Markets at the bottom of the economic pyramid are fundamentally new sources of growth for multinationals. And because these markets are in the earliest stages, growth can be extremely rapid.

Another big misperception about developing markets is that the goods sold there are incredibly cheap and, hence, there's no room for a new competitor to come in and turn a profit. In reality, consumers at the bottom of the pyramid pay much higher prices for most things than middle-class consumers do, which means that there's a real opportunity for companies, particularly big corporations with economies of scale and efficient supply chains, to capture market share by offering higher quality goods at lower prices while maintaining attractive margins. In fact, throughout the developing world, urban slum dwellers pay, for instance, between four and 100 times as much for drinking water as middle- and upper-class families. Food also costs 20% to 30% more in the poorest communities since there is no access to bulk discount stores. On the service side of the economy, local moneylenders charge interest of 10% to 15% per day, with annual rates running as high as 2,000%. Even the lucky small-scale entrepreneurs who get loans from nonprofit microfinance institutions pay between 40% and 70% interest per year—rates that are illegal in most developed countries.

It can also be surprisingly cheap to market and deliver products and services to the world's poor. That's because many of them live in cities that are densely populated today and will be even more so in the years to come. Figures from the UN and the World Resources Institute indicate that by 2015, in Africa, 225 cities will each have populations of more than 1 million; in Latin America, another 225; and in Asia, 903. The population of at least 27 cities will reach or exceed 8 million. Collectively, the 1,300 largest cities will account for some 1.5 billion to 2 billion people, roughly half of whom will be bottom-of-the-pyramid (BOP) consumers now served primarily by informal economies. Companies that operate in these areas will have access to millions of potential new customers, who together have billions of dollars to spend. The poor in Rio de Janeiro, for instance, have a total purchasing power of $1.2 billion ($600 per person). Shanty-towns in Johannesburg or Mumbai are no different.