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September 20, 2010 12:12 am
When Reuben Abraham, a professor at the Indian School of Business (ISB), convinced a hedge fund to take the risk of investing in a small waste management group in Mumbai, few believed it would grow into a $100m business in less than four years.
The lack of confidence in a small enterprise’s ability to yield both high returns and socio-economic development highlights the challenge that many emerging economies face: providing affordable services of a high standard to the bottom of the pyramid – the millions of people earning only a few dollars a day.
Ever since C.K. Prahalad’s article “The Fortune at the Bottom of the Pyramid” was published in Strategy+Business, a US magazine, in 2002, multinationals have piled into India to provide cheaper versions of their products to the poor. Their entry into the Indian market gave stellar returns to their investors and played a fundamental role in providing new jobs and products to consumers more used to having limited choices. But the capital injection led to a spike in inequality as the benefits of economic growth failed to trickle down fast enough to the bottom of the pyramid.
The ISB, India’s only school ranked in the Financial Times MBA ranking, was one of the first to recognise the challenge of finding ways to marry high returns with socio-economic development. Located in an exciting emerging economy, it decided to focus on helping small businesses exploit market opportunities overlooked by big enterprises.
Its strategy has been unique. In 2008, the school opened its doors to a range of international funding providers – the Soros Economic Development Fund, the Omidyar Network and Google – to create an in-house fund called Song (from the names of its funders) to finance small companies that had a positive socio-economic impact.
“We set up a partnership with the investors out of a conviction that business schools have to go beyond their traditional boundaries to support the development of a profitable small and medium-sized enterprise (SME) sector that has an outsized social impact,” says Ajit Rangnekar, dean at the ISB.
Abraham, who now heads the ISB’s Centre for Emerging Markets Solutions, says the hedge fund’s successful investment in the waste management company in Mumbai proved that it was possible to get high returns out of socially sound ventures. “It’s thanks to that positive experience that I managed to get Soros and the others on board,” he says. “It gave them confidence we could do it again and again.”
He says the school’s “aim was to reproduce positive examples and act as a catalyst in improving access to risk capital in the SME segment, which is crucial to job creation”.
At the moment, Abraham says, there is an overpricing of risk. But, thanks to the ISB’s research facilities, he believes the risk factor can be reduced by providing reliable information to investors to help them make an educated bet on a company that will have a social impact.
“We want to focus on sectors that can contribute significantly to the socio-economic development of India, such as education, healthcare, agriculture and housing,” he says. However, he warns that the fund is not a charity. “The money raised for the projects that are selected is soft capital to launch a company. It’s not philanthropy.”
He adds: “We want to prove that you don’t have to compromise returns for socio-economic development. I won’t say it’s easy to make money out of the bottom of the pyramid, but if you look harder, you’ll find a lot of gems out there, just like the waste management company that the hedge fund manager backed.”
Abraham says most investments made by foreign investors who seek large returns have gone into big companies, in particular those in the information technology sector. “There is little interest in other business segments that could have had a positive socio-economic impact and high returns,” he says.
Big funds’ lack of interest in small ventures attracted the attention of Song, which has seen opportunities in the largely untapped bottom of the pyramid investment segment. At present, Song, which manages a $17m fund, has invested roughly $4m in two projects.
Together with Sequoia Capital, the venture capital group that helped launch Google in the 1990s, it backs K12 Techno Services, a school management company focused on providing affordable schooling in south India.
“The plan is to create a teaching and school management scheme that can be taken across India and implemented at very low cost,” says Kartik Srivatsa, an investment manager at Song who oversees the project.
Song’s other major investment has been in Eye Q Vision, a chain of high-quality, low-cost eyecare hospitals based in the north of India.
Having an in-house fund has allowed students at the ISB to play a key role in evaluating a real investment scenario, he says. “The ISB is our knowledge partner. We work with the school to find investment opportunities that we believe can be scaled up, and its students can take home a real working experience.”
The ISB has also opened its doors to other investors in the past two years, who have used its emerging markets centre to test what most financiers would see as non-viable ventures.
Dhaval Monani, who used to work for a Spanish private equity fund in India, says that when he looked for opportunities to invest in affordable housing projects, he could not find any. “It seemed crazy there was nothing around.”
After meeting Abraham, he decided to join the ISB’s emerging markets centre. He used the facilities to build a model for a company to design houses that cost as little as Rs300,000 ($6,500).
“After a lot of research we are now developing houses that will be affordable for people earning Rs7,000 per month,” he says.
The ISB’s goal is to develop solutions for other sectors to be applied in all emerging markets, in particular in Africa and Latin America.
“We want to build more than an ecosystem for south India,” says Abraham. “We want to develop models that can be exported to the rest of the emerging world, and developed economies too.”
Citing the role that Stanford played in developing Silicon Valley, Abraham’s vision is clear.
“Ten per cent of my students are likely to cover influential roles in the future,” he says. “I want to change their mind-set, and I want them to see the bottom of the pyramid in a different way – as a market and an opportunity to develop.”
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