Aim for the base of the pyramid
Sunday, 01 May 2011
Nearly 200 new social impact funds launched in the last three years alone. Christine Ribeiro argues big business does well when it backs small-timers
When Anglo American, a US $50 billion global mining company, tried to integrate a number of smaller businesses into their supply chain in the 1980s, they ran into a problem. They couldn’t find any. They started with South Africa, in search of companies specialising in equipment design and repair, construction, civil engineering and security companies.
When they tried to find out why, they discovered the main reason companies could not meet their needs was a lack of access to financing. While they first turned to banks to fill the financing gap, it became clear that if they wanted to grow their supply chain, they would have to do it themselves. Besides, they had the buying power.
"Back in 1989, we realised that it made sense for us to invest in our local communities from a competitiveness and procurement standpoint but we couldn’t find banks to lend to the smaller entrepreneurs operating in these areas. So we had to come in and provide the funding and since then, this model has just taken off," says Nick van Rensburg, CEO of Anglo American Zimele, the enterprise development and investment fund of Anglo American South Africa. "By investing in the entrepreneurs along our value chain, we are reaping the benefits as a company." Anglo American CEO Cynthia Carroll says the company spends $10.4bn a year on procuring goods and services, and three quarters of that comes from developing countries. "The amount that we spend each year in procurement from emerging market economies is comparable to the aid budgets of the UK, France or Germany," says Carroll.
The Anglo American Zimele fund was set up to provide financing for entrepreneurs interested in creating businesses that fit into Anglo’s supply chain. Initially seen as purely a financial investment, the fund started out with small loans and equity financing. The model has evolved through the years, but the profitability and importance to the company’s core business remains the same.
Over time, the model expanded to include mentoring and skills transfer, which has improved the success rate of the companies invested in, and ultimately the strength of Anglo American.
Both the small business loans and knowledge are transferred through their enterprise development hubs. There are currently 25 hubs in South Africa with 11 more on the way. Another addition was a larger scale junior mining fund that can provide loans of up to ZAR14 million ($2m) to establish smaller mining companies as well as technical assistance for high-risk exploration.
This model has proven immensely successful. The fund has a 90% repayment rate and made about $2.5m in profit from 2004-2007. In 2009, Anglo American invested close to ZAR40m ($6m) to over 500 businesses, which were responsible for employing 9,570 staff members.
In 2008, about 40% of their procurement was from their SMEs. Anglo American is now looking to expand the model of enterprise development hubs in Chile and Brazil. Van Rensberg says that they will continue to roll out and expect to have 50 hubs by the end of the year.
Banks cotton on
Investment in inclusive business models, which create positive financial returns and integrate low-income communities into the value-chain as suppliers, distributors or end users, is gathering pace. Anglo and others recognise this is an area of huge potential growth. A recent report by the IFC and McKinsey & Co estimates close to 400 million micro, small and medium enterprises (MSMEs) around the world do not have access to financial services.
In the last few years, investors have begun to take notice.
With a potential global market of $2.1-2.5 trillion, impact investors who focus on investments in inclusive business models have grown exponentially in the last few years. According to Jacqueline Novogratz, the founder of Acumen Fund, 192 new social impact funds were launched in the last three years alone.
This growth is set to continue. JP Morgan and the Rockefeller Foundation say impact investing will reveal itself to be "one of the most powerful changes" within the asset management industry in years to come. The largest opportunities are in sub-Saharan Africa, where less than 20% of MSMEs have access to financial services.
The World Resources Institute and International Finance Corporation estimate that the Base of the Pyramid (BoP) market in Africa is valued at $429bn. In fact, this segment is the region’s dominant consumer market with 71% of purchasing power - representing 486 million people.
A number of companies have already made significant profits through investments in inclusive business models in Africa. Anglo represents only one example; through investments in market research and new product design they were able to expand their market significantly. Other companies have taken different investment approaches (see box).
Investors have begun to notice that Africa is ripe with opportunity for investments into SMEs. From 2001 through to the first half of 2010, Africa attracted 43% of all funds going to support SMEs in emerging markets, according to Dalberg market analysis. They are reaching SMEs through a combination of traditional investment and innovative approaches to create profitable returns.
Anglo American is among those who have shown it is possible to create a profitable investment fund that looks at value chain models. While Anglo had the capital to create their own investment arm, many companies either do not have funds available or would rather work with experienced third-party funders while they focus on their core business.
The Coca-Cola Company, for example, works through Micro Distribution Centres (MDCs) in key east African markets. MDCs shorten the supply chain, cutting out unnecessary wholesalers, and create increased business and income opportunities for SMEs as distributors of Coca-Cola products. Coca-Cola has set up education for these small business owners and is seeing the impact.
According to Adrian Ristow, Project Director of micro-distribution for The Coca-Cola Company, the company has explored various financing options, including large financial institutions, development agencies and guarantee funds.
Other successful investors in value-chain financing include Root Capital, a social investment fund that manages more than $30m and uses a factoring model to guarantee loans with up to 12% interest rates to grassroots producers, resulting in a 99% repayment rate.
Thus, short-term working capital loans are made to small producers with future sales contracts from large companies, such as Starbucks and Marks & Spencers, as collateral. Once the buyer receives the product, the loans are paid back directly by the buyer and the remainder of the payment due goes to the farmer. This model helps minimise the risk involved with lending to SMEs and, on a large scale, can prove quite profitable.
Investors can also look at models of investing directly in companies that provide products and services to BoP markets.
The Acumen Fund is a tenyear old social venture investment fund that has invested $60m in 57 companies in Africa and South Asia. They use patient capital with a range of $300,000 to $2.5m in equity or debt, with payback or exit in roughly five to seven years. They invest in early-stage enterprises that provide low-income consumers with access to healthcare, water, housing, alternative energy, or agricultural inputs.
GroFin, an SME investor managing six funds totalling more than $260m, is one of the best examples of an Africa-based SME investor.
GroFin provides tailored debt and equity solutions ranging from $50,000 to $1.5m as well as management training, business services and exit support to ensure its clients thrive in the marketplace. Unlike other financial institutions that have standard requirements, GroFin evaluates firms on a case-by-case basis, evaluating the ability to make long-term revenues.
While interest rates are set based on the risk level of the loan, the average return is about 10%. Over the last six years, GroFin has steadily grown both the size of their fund and portfolio, taking advantage of BoP markets across the continent.
How to do it
Investors are moving into this space, but there is still a lot of room for growth. McKinsey and IFC estimate that an investment of $80-$100bn is needed to close the financing gap in sub-Saharan Africa, an increase of more than 300% over current investment. However, despite the large market and potential for profit, many investors are unsure how to enter into SME or BoP financing.
Organisations such as the Aspen Network of Development Entrepreneurs (ANDE) are working to help educate and create standards for BoP investing. ANDE, a global network of investors, foundations, NGOs and academic institutions focused on small and growing businesses in BoP markets, focuses on providing funding and technical assistance to promote an ecosystem of support for BoP businesses.
They recently launched investment manager training in Nairobi that covered the entire investment process for BoP markets, from dealsourcing to exit strategies.
Watching leading companies in this field can also help investors understand trends and best practices.
Initiatives such as the Business Call to Action (BCtA), a global leadership platform for companies that implement inclusive business models, allows investors a front-row look at the next big thing. Such third-party knowledge sharing platforms also provide a place for investors and the private sector to enter into open discussions and investigate ways to partner.
The BoP market in Africa is large and ripe for investment. As more investors move into this space and the SME sector is strengthened, the continent will see value-add in much the way Anglo American did. By strengthening the bottom of the valuechain, investors can create an impact in Africa that will place Africa on a sustainable, and inclusive, spiral of development.