When companies figure out how to serve low-income consumers in developing countries profitably, everyone wins: the disadvantaged gain access to products and services that the private sector is best positioned to deliver, while companies tap into vast new markets. On top of that, when core sectors of the economy—such as banking, electricity, telecommunications, and water—thrive, they transform consumers into producers and promote economic development.

Unfortunately, this happy dynamic is more the exception than the rule. Low-income consumers just can't afford many products and services. A shaky infrastructure raises the costs of distribution. Incomplete information makes extending credit difficult, and collecting what's owed poses enormous challenges. Some low-income consumers feel entitled to connect into water mains or electricity lines illegally. Low-income environments are also more susceptible to insurgent activities that raise security and infrastructure costs.

To complicate matters, the resolution of these issues sometimes calls for untangling a unique principal-agent problem. A company (the principal) is in a weaker position than the community (the agent) when it comes to gaining local information, shaping people's views, and dealing with bad behavior—by defaulters, for example—that could disrupt service for customers and company alike.

A few companies are adopting creative community-based solutions to overcome many of the difficulties they face serving low-income consumers:

• In the Philippines, Manila Water relies on collective billing to ensure the timely payment of bills, employs small-scale entrepreneurs as couriers and pipeline contractors, supports microlending, and brings affordable water to schools and hospitals. The mobile-telephony providers Globe Telecom and Smart Communications use initiatives (ranging from educational programs to food and medical assistance) that benefit the whole community to encourage local leaders to safeguard cell towers and protect company employees.
• In Mexico, Cemex's Patrimonio Hoy program broadens access to services and to cement and other building materials by organizing low-income customers into groups of three families that monitor each other's progress in constructing their own homes and collectively pay off debts at regular ten-week intervals. To promote and monitor the program, Cemex employs people, such as teachers and church leaders, who have large personal networks and are widely trusted.
• In India, Hindustan Lever has developed Shakti, a program that trains rural women to operate as entrepreneurial distributors of consumer products in villages of fewer than 1,000 people. This effort generates annual sales of roughly $250 million in villages that would otherwise be uneconomic to serve.

Some of the benefits are directly measurable. Manila Water serves 5.1 million residents, has trained more than 1,000 engineers, and disburses a $16 million annual payroll in impoverished east Manila. The distribution of mobile-telephony services in the Philippines generates roughly $200 million a year for more than one million small-store proprietors. Cemex has made home ownership a reality for 70,000 low-income Mexican families. Hindustan Lever's Shakti program provides annual cash flows of roughly $25 million to its female distributors. And the Grameen Bank of Bangladesh, which along with founder Muhammad Yunus won the 2006 Nobel Peace Prize, has made small loans to 6.6 million people while providing services in more than 70,000 villages.

Less quantifiable benefits are just as important. Cheaper, higher-quality water frees up income for other purchases and raises the quality of life and health. Reliable telecom services help farmers ascertain market prices, make it less necessary to use bad roads, and provide a substitute for weak postal services. Home ownership raises the net worth of families, makes them more safe, and generates self-esteem. In addition, many of these programs promote a culture of entrepreneurship.

In view of the benefits, it might seem natural to describe community-based initiatives as a form of corporate social responsibility. Yet in most cases, the local initiatives actually make the business sustainable. Addressing social issues, in short, isn't adjacent to strategy but rather central to it.

What are the obstacles?

The higher costs of doing business and the fundamental principal-agent problems prevalent in low-income markets will take on growing importance in the future: at least ten of them are in fast-growing economies that together represent about half of the world's population and nearly $15 trillion in income.¹ Within such economies, the most important—and difficult—business sectors for solving the low-income challenge are those where the expected profit is low but the potential impact of successful penetration is high (Exhibit 1). Water and mobile telephony are prime examples, and the Philippines is a prototypical low-income market: the bottom 90 percent of households, representing more than 60 percent of the country's purchasing power, each earn an average of less than $300 a month.

Familiar, but more daunting . . .

Some of the factors that raise the cost of serving poor consumers are actually acute forms of challenges that businesses confront across all consumer segments.

Customer acquisition and parceling. When low disposable incomes limit the amount consumers can buy at any one time, it becomes extremely important to deliver products and services in affordable parcels, such as single-use packets of products like shampoo or detergent. Consider the problem faced by Globe Telecom and Smart Communications, operating in a country where a mobile handset costing 3,000 pesos (roughly $60) might represent 20 percent of an average low-income consumer's monthly wages. Acquiring new customers was virtually impossible without radical changes in the parceling and pricing of services.

Collection. Consumers in low-income segments have trouble saving money, given their pressing need for liquidity. This factor makes the collection problem acute for sectors such as telecom services and water, where consumers generally receive bills after consumption. Furthermore, the difficulty (and sometimes the danger) of locating and contacting delinquent consumers raises costs. And the harder it is to collect, the higher the eligibility standards that companies must set for their customers; this in turn reinforces the problem of acquiring new ones.

Infrastructure. Low-quality roads, postal services, electricity, and other basic forms of infrastructure make it harder and costlier to support production and distribution in many areas. A large number of households in Manila Water's target market, for example, live in shanties that lack proper faucets, toilets, or in-house piping. As a result, not only service providers but also potential customers must start from scratch. For customers, the cost of installing basic plumbing can be substantial—around 7,000 pesos, or more than 40 percent of the average monthly income.

. . . and unusual

Other difficulties are less familiar to companies that primarily serve more affluent consumers.

Desperation. As a result of a 1997 privatization initiative, Manila Water has the right to sell water in the eastern part of the metropolitan area. Before then, all of it was served by a government monopoly, and roughly 65 percent of the water that left the treatment plant was "nonrevenue water." A weak infrastructure was responsible for a good deal of the problem, but as much as one-third of it resulted from pilferage. Consumers felt that they had to make illegal connections to the pipeline in order to obtain water—something vital to the hygiene and health of their families. But pilferage jeopardizes the long-run provision of services.

Security. Large concentrations of low-income consumers who endure high unemployment and receive minimal government support are ripe targets for radical political and social groups that encourage resistance to contracts and threaten corporate assets. Since 2002, for instance, lawless elements have damaged more than 30 of Globe Telecom's cell sites in retaliation for the company's refusal to pay "revolutionary taxes." Protecting infrastructure from straightforward theft is also a problem: copper cables belonging to Globe Telecom and Smart Communications have been cut and sold as scrap metal.

Education and culture. Companies must often invest to overcome or accommodate mind-sets that undermine consumer participation in conventional market transactions. In the Philippines, for example, there is a ubiquitous custom of "five-six" lending: borrowing five pesos and repaying six, usually within a week, for an annual interest rate of roughly 13,000 percent. Since low-income consumers, lacking good information and formal education, don't understand the implications of this kind of borrowing, they wind up even poorer and further removed from the economic mainstream.

The solution lies in the community

Running through many of these challenges is a classic principal-agent problem: a variety of agents (consumers and community leaders) may act in ways that are not necessarily in the best interests of the principal (product and service providers). For the phone companies and Manila Water, the conventional solution would be to safeguard thousands of base stations and hundreds of miles of pipeline with security guards, police protection, and enclosures. Since tactics like these would be prohibitively expensive, companies need creative business models to resolve principal-agent problems in a sustainable way.

People in local communities—not only the mayors and barangay (village) captains but also school principals, teachers, religious leaders, and residents themselves—are in the best position to help companies deal with the challenges of doing business in low-income areas. These community agents have the information and ability to monitor and influence what happens on the ground. If a company can show that its own interests are aligned with their interest in employment and commerce, it can then enlist community support for security, collection, and system monitoring. Community-based approaches help companies address principal-agent issues head on while creating a positive dynamic that reinforces key business model adaptations (Exhibit 2).

To understand these dynamics, consider what happens when a telecom company provides service in an area. Rising local employment at the company and its suppliers stimulates local economic activity. Meanwhile, telecom services make transportation, the flow of information, and the fulfillment of transactions cheaper and easier. These second-order benefits make the community better off, which of course stimulates demand and improves the way the community perceives the company. Improved alignment between the community and the business, in turn, makes it easier to address issues such as security and pilferage. Education and initiatives that make communities more aware of the broader economic and social role that companies play can reinforce the positive dynamics or reverse negative ones.

While tapping into these commercial and community dynamics, Manila Water, Globe Telecom, and Smart Communications have delivered strong returns on invested capital—around 19 percent, 16 percent, and 17 percent, respectively, over the past three years. Let's explore the stories behind the numbers at Manila Water and Globe Telecom.

How Manila Water does it

To overcome the difficulties in acquisition and collection, Manila Water devised a game-changing scheme: letting communities themselves decide if they want individual or collective installation, metering, and billing. The company offers three options: one meter per household, one meter for 3 or 4 households, and a bulk meter for 40 to 50 households. Where households band together, the connection fee (ordinarily 7,000 pesos a household) can fall by as much as 60 percent, depending on the number of customers who shoulder the cost of pipes, the meter, and installation. Submeters measure water usage in each household, and everyone on a group meter takes responsibility for paying the total bill, an arrangement that in effect gives consumers (and Manila Water) group insurance coverage on payment.

About 30 percent of the urban poor served by Manila Water now pool their bills, and in communities using this technique the company collects 100 percent of the money they owe. Consumers recognize both the savings from collective installation and the fact that ensuring sustained service depends upon their own actions. Tied households, given their close proximity, can observe and shape day-to-day behavior, encourage the cluster's members to meet their obligations, and impose sanctions on those who don't.

Nonetheless, some low-income consumers still make illegal connections to the company's pipelines. Furthermore, winning cooperation from local officials—absolutely essential for a heavily regulated business—is problematic for a company like Manila Water, which eschews the bribes and other extralegal practices many businesses accept. The company's response has been to come up with several community-based initiatives. They include the following:

• Providing jobs to more than 10,000 people, either as couriers who deliver Manila Water's bills or as contractors who help lay pipelines; the company also fosters the development of small supplier businesses and cooperatives, such as printing outfits.
• Bringing clean, affordable water to public schools, hospitals, and markets—institutions of great importance to the broader community—while addressing the sanitation needs of low-income residents.
• Increasing awareness within the community that illegal connections pose a risk to the long-run provision of water and that canned water is seven times more expensive than the company's offering.
• Making small loans, in partnership with Bank of the Philippine Islands and the International Finance Corporation, to organized groups operating microenterprises such as street stalls and food services.

Combined with collective billing, these actions are solving the principal-agent problem by giving agent communities a vested interest in principal Manila Water's viability. As people see their living conditions and productivity improve, they become more willing to monitor water connections, protect infrastructure, ensure timely payment, and win over local-government officials.

Globe's approach

Globe Telecom began expanding into lower-income segments in 1998 because the top of the market was too small to support the capital expenditures required to extend the company's mobile network throughout the Philippines. Its initial push involved selling prepaid service cards in denominations of 300 and 500 pesos. Although the prepaid scheme eliminated most of the problems associated with billing, assessing credit risks, and collection while significantly expanding the market, the cards were vulnerable to theft. Furthermore, manufacturing and distribution costs made it uneconomic to offer cards worth less than 300 pesos, and at around $6 these were pricey for many consumers.

Globe responded by delivering small-value bundles through over-the-air (OTA) reloading: customers pay a licensed distributor for network access. Since the costs associated with OTA are almost zero, it can involve whatever amount of money the customer wants, down to a single peso. The customer takes a mobile phone to a sari-sari store (small roadside variety shops preferred by 90 percent of Philippine consumers) or a village store, gives the proprietor the money, and the proprietor uses a mobile phone to transfer a load onto the customer's phone. The customer can then make calls until the credit is used up. OTA to wholesalers has eliminated the opportunity for card heists while allowing Globe—and Smart, which also employs OTA—to relax the eligibility requirements for wholesalers. (After all, the companies can swiftly identify and take action against slow-paying ones.) Both credit risk and the initial cost of setting up shop decline. As a result, the benefits are being felt by an army of proprietors; their numbers have swelled from 50,000 in 2003 to more than 400,000 in 2006 for Globe alone (and to more than 1,000,000 in the industry as a whole).

Providing a livelihood for shopkeepers is just one of the many ways Globe is deepening its ties with low-income communities where the company has assets, such as base stations, offices, and business centers. There are others as well:

• Providing aid (including food, medical missions, books, and educational TVs) for primary schools, as well as an engineering curriculum for vocational schools; Globe tailors programs to local needs by consulting community leaders, who frequently, in turn, become supporters of the company's broader activities.
• Building awareness of the way mobile services help people and communities to flourish, such as giving farmers updates on weather conditions and rapid, low-cost access to market prices.
• Using mobile handsets as an electronic payment mechanism to deliver credit safely and cost effectively. The phone sends payments from one individual or business to another (much as some consumers use PayPal for Internet transactions), so the lender can see how the person receiving the money actually spends it, in real time.

As the link between Globe Telecom and employment-income, education, and medicine becomes more explicit in people's minds, low-income communities help the company both to protect its assets and employees and to deepen its subscriber penetration.

Exportable lessons

Some clear lessons emerge from the experiences of Manila Water and Globe Telecom, as well as other budding leaders, such as Cemex, Hindustan Lever, and Smart Communications. Communities are frequently in a better position than companies are to resolve issues that make it uneconomic to serve low-income groups. Building awareness of the benefits that a company can bring is essential for resolving principal-agent problems. And companies that want to solidify their role in low-income communities must typically provide economic benefits beyond the direct impact of their core products and services.

Within these broad guidelines, three business model archetypes are emerging (Exhibit 3). Each addresses different aspects of the low-income challenge and can be used individually or in combination. The first— "collective accountability"—focuses on collection problems associated with either direct lending or postpaid services. This approach involves developing small groups, such as Cemex's family clusters or Manila Water's collective-billing units, whose members substitute for the monitoring efforts of the business itself and provide "social insurance" to one another.

The second business model—"scalable, embedded distribution"—reduces costs and promotes a company's reputation by enlisting trusted community members (such as the sari-sari proprietors, Cemex's Patrimonio Hoy monitors, and Hindustan Lever's entrepreneurial women) to provide the distribution infrastructure for goods and services. The challenge, of course, is how to recruit, train, and manage an army of community-based agents. Hindustan Lever, whose Shakti program has expanded from 50 villages with 150 rural women in 2001 to 80,000 villages with 25,000 women entrepreneurs today, has created a four-week training program for all participants and employs some of the company's leading entrepreneurs as trainers.

Companies that use the third of these business model archetypes—"livelihood partnerships"—surround a core product or service with additional benefits. Rather than treating communities purely as collections of consumers, companies that take this approach provide low-cost, productivity-enhancing assistance, such as Manila Water's training and cooperative business programs. These initiatives bridge cultural gaps between company and community, create positive associations with the company's brand, raise switching costs, and promote micromarket activity. All this has positive consequences for both the community and the companies doing business there.

All three approaches involve deep, long-term community relationships and investments, whose value is illustrated by the extraordinary support Manila Water received when it asked regulators for a rate increase in 2002. Ninety barangay captains and community leaders showed up at the hearing and expressed their appreciation for the powerful positive impact Manila Water had on their communities. These people told stories about the way residents formerly began their trek at midnight to get water back to their households by dawn, about new jobs and entrepreneurial activity, and about Manila Water's support for the community's special needs and projects. To these local leaders, Manila Water had become an essential partner in their livelihood and quality of life; they were prepared to stand by the company.

Serving the bottom of the income pyramid may seem daunting. But by crafting community-based strategies that reflect the distinct characteristics of the low-income segment, companies can tap into a huge growth opportunity for themselves and achieve competitive rates of return while also delivering important developmental benefits to the communities they serve.