Blue Collar Rocket Science

This is my final paper for the Master of Communication in Digital Media program’s Emerging Markets in Digital Media class, taught by the insightful and capable Anita Verna Crofts. I had a lot of time for research and preparation in writing this paper, and was drawing on topics in which I have considerable professional experience and personal passion. But I also began my full time job at KCTS Television at the same time that I was writing the paper and preparing the accompanying presentation. In the ensuing time crunch I was unable to give the paper as much attention as it deserved and feel it is essentially a first draft. I believe that there’s potential to turn this idea into a real business model that could do much to help the living conditions in many countries.

See also: eCommerce Cooperatives in Emerging Markets Flash Presentation for an animated presentation on how the business model might work.

Brook Ellingwood
COM 597: Emerging Markets in Digital Media
Instructor: Anita Verna Crofts
December 18, 2009

Table of Contents

• Introduction
• Prahalad’s Pyramid
• Units and Economies of Scales
• The Co-operative Business Model
• Moving Up the Food Chain for Economies of Scale
• History and Principles
• Familiar Examples
• The eCommerce Business Model
• Large Reach for Economies of Scale
• Assumption of Familiarity
• Assumption of Success
• eCommerce Retail Co-ops: Economies on Economies
• The Practicality of eCommerce
• Usability Challenges
• Applying the Co-op Model on Top
• The Importance of Co-op Governance
• The Pitch for Developing a Business Plan
• Appendix I: ICA Principles
• Statement on the Co-operative Identity
• Definition
• Values
• Principles
• References

Introduction

The spread of mobile technologies to emerging markets worldwide, and the introduction of electronic funds transfers to some markets, suggests the possibility of introducing ecommerce business models to these markets. Both as a means of facilitating the success of these ecommerce businesses, and to further the goals of poverty elimination, these ecommerce startups might be structured as members-owned retail co-operatives.

Prahalad’s Pyramid

C. K. Prahalad, Professor of Corporate Strategy at the University of Michigan’s Ross School of Business, proposed an approach to eliminating poverty through capitalist mechanisms in his popular book “The Fortune at the Bottom of the Pyramid: Eradicating Poverty through Profits.” His vision is one of economic growth through commerce targeted to the needs of poor populations, raising standards of living, spurring local job creation, and breaking a cycle of handouts from richer nations.

Prahalad’s argument is persuasive, and it’s hard to look at the remarkable economic growth of America, Western Europe, and Japan in the past 50 years without seeing it as an illustration of the power of consumer spending. While the recent economic downturn has perhaps hinted at the safe limits of credit-driven consumption, Adam Smith’s invisible hand still seems to give us a thumbs up when we go to the mall and perform our patriotic duty by buying socks.

In his book, Prahalad urges the large multinational corporations that make basic consumer goods, Unilever is an example, to invest in packaging and distributing their products in ways mindful of the needs of the world’s poorest consumers and the environments in which they live. His view is that this investment will pay off by opening up an even broader customer base.

Units and Economies of Scales

In a table reprinted from the Harvard Business Review Prahalad illustrates that not only are the poor lacking access to easily purchase goods and services packaged and distributed in ways suited to wealthier customers, but that when those goods are services are available they cost the poor significantly more on a per unit basis than they do the wealthy. The handful of examples range from a 1.2X premium on the cost of rice to a 53X premium on the interest paid on borrowed money (Prahalad, 2006). As a practical illustration, this means if an individual with a reliable middle-class income were somehow forced only to purchase goods and services at the costs charged to the poor, that individual’s standard of living would drop even as his or her income stayed the same. This binds the poor even tighter to their situation.

Prahalad doesn’t use the term, but this trap is an application of economies of scale. Microeconomics teaches that more of something is produced, the cheaper the production and distribution costs, and the higher the potential profit. As Prahalad demonstrates, most multinational corporations apply economies of scale by trying to minimize unit costs and maximize the profits per unit. He illustrates this in the context the single-use packets of shampoo.

Single-use shampoo packets are cheap because their per unit retail price is low. A quart of shampoo costs the customer a lot more, because it contains a lot more shampoo. But if we look at usage costs, we see that the customer who buys the quart bottle spends considerably less each time he or she shampoos. The poor are paying a premium per use in order to have access to unit packaging they can afford.

Unilever packages shampoo according to the rules of economy of scale in order to make a profit. But Prahalad argues for a different profit model based on volume. Unilever could increase the production of single use packets, thereby lowering their per unit cost, and then pass the savings on to poor customers to spur an increase in sales.

I can’t disagree with Prahalad’s models, or his vision. If the multinational corporations that sell products in both developed and emerging markets were to pursue new tactical approaches to sales at the bottom of the pyramid, I’m sure they would profit handsomely. But corporations have cultures, assumptions, and stockholders. Getting them to a point of comfort with BOP approaches could take decades.

I also wonder about new inefficiencies in the model. For example, those shampoo packets are handy, but they also have to go somewhere when they are empty.

Why can’t we just try to make it easier for the global poor to buy the way the wealthy do? What if we just let the multinationals keep doing what they do, and looked for ways to add economies of scale into local sales and distribution channels?

The Co-operative Business Model

Moving Up the Food Chain for Economies of Scale

While co-operative businesses give many reasons for their existence, I suspect that an examination of most, if not all, successful co-ops will find that they are taking advantage of economies of scale to benefit their members. Invariably, co-ops take on a “middleman” role that acts in members’ interest, supplanting the previous “middleman” enterprise that acted in its own interest. By moving members’ collective interests farther up the business food chain, co-ops provide collective economies of scale.

History and Principles

Various forms of co-operative businesses have likely existed since the invention of commerce, but the co-operative movement began in England in 1844 with the Rochdale Equitable Pioneers Society. Founded by 28 workers in the cotton mills in the town of Rochdale whose wages were not adequate to buy food, the Rochdale co-op allowed them to pool their money and through economies of scale pay less for four staples: flour, oatmeal, sugar and butter (ICA, 2005).

Unlike stores following the traditional capitalist model, in which the owners sells goods to customers and keeps the profit for their own enrichment, the store run by the Rochdale Pioneers was owned by the customers and the profit was applied to reducing the prices of the goods sold. The demonstrated success of the Rochdale model led to the spread of co-operatives around the world. These ranged in ambition from small stores to credit unions to whole utopian communities.

During the Great Depression co-operatives attracted attention as a “middle way” between capitalist economic models and statist economic models, such as Communism or Facism. The phrase itself came from the book “Sweden: The Middle Way,” which promoted the success of co-ops in that country (Childs, 1936). In 1937, the International Co-operative Alliance adopted a set of principles for co-ops based on the Rochdale model. These principles were last modified in 1995, and define member benefits and organizational responsibilities. (See Appendix I: ICA Principles.)

Familiar Examples

Following are a few examples of co-operatives I am familiar with due to a shared regional connection:

• Established in 1886, the Puget Sound Co-operative Colony ultimately failed as a co-op community but played a major role in the establishment of Port Angeles, Washington as a viable town (Oldham, 2007).
• Regional credit unions, essentially an application of co-operative principles to banking services, include BECU, which was founded in 1936 and now has over 600,000 members and over $8.6B in assets (BECU, n.d.).
• The Seattle Teachers Credit Union (now School Employees Credit Union of Washington) spawned PEMCO Inurance Company in 1949 (PEMCO, n.d.).
• Group Health Cooperative (which as a healthcare organization does not follow the Rochdale member-controlled equity cooperative principle) pioneered the Health Maintenance Organization model of containing healthcare costs with its founding in 1945, and now also has over 600,000 members (Crowley, 2000).
• Puget Consumer Co-op began as a food buying club with 15 member families in 1953, and now is the nation’s largest natural food co-op, with nine stores, and 40,000 members. Non-members are allowed to shop as well (PCC, n.d.).
• Recreational Equipment Inc. was founded as a consumer co-operative by 21 member in 1938 (REI, n.d.) and has grown to have yearly sales of nearly $1.5B (REI, 2008).

From 2004 to 2008 I was an employee of REI, working as a manager in their ecommerce operation, and much of my thinking in this paper is influenced by that experience. REI has been the subject of occasional criticism that it may no longer be following the spirit of Rochdale model in its approach to governance and obligation to member value (Ryan, 2003). While I’m not interested in addressing this particular argument, the questions that it raises with regards to ongoing governance are import to my proposal.

The eCommerce Business Model

Large Reach for Economies of Scale

eCommerce businesses are able to make sales anywhere potential customers with a digital media client and an electronic means of payment have access to a network. Fulfillment of those sales can happen anywhere there is a distribution system in place. In developed countries it’s very easy to find these conditions, and take advantage of them to leverage the economies of scale provided by a large pool of potential customers into a successful business.

Assumption of Familiarity

This paper assumes the reader is familiar with the basic mechanisms of ecommerce. In this proposal, we will look at four key steps in the ecommerce process:

• Searching or browsing an online catalog of products available for sale
• Choosing desired products and placing them in a virtual shopping cart with indication of quantity desired
• Paying for items in the shopping cart using an electronic payment system
• Having purchased items delivered to a specified location

Assumption of Success

This paper also assumes that ecommerce has been proven as a successful business model, and that the sources of its success are known to the author through professional experience.

The success of ecommerce as a business model is predicated on being more efficient than traditional physical retail. Efficiencies achieved include:

• No need to maintain multiple physical retail locations with associated sales staff
• Centralized inventory of retailer-held items in a minimal number of locations instead of distributed inventory across many physical stores
• Direct from manufacturer shipping for certain items, avoiding the additional overhead of maintaining any inventory in them at all
• Negotiated shipping rates, in which the promise of a high volume of shipments results in reduced rates
• Centralized payment, reducing accounting and financial services costs

eCommerce in countries with advanced consumer economies has proven to be a success. But is it possible to apply an ecommerce model to a country with a significantly less-developed infrastructure, and if so, what would it look like?

eCommerce Retail Co-ops: Economies on Economies

The Practicality of eCommerce

Prahalad’s discussion of unit pricing essentially points out that conditions already exist for multinational companies to pursue profitable business tactics that improve the standard of living of poor customers and develop the markets in which they live. Likewise the conditions for ecommerce sales and fulfillment already exist in a number of emerging markets.

• Ubiquity of Mobile Phones. Any number of sources can be cited to demonstrate the incredible spread of mobile telephone networks in developing countries (For example, Ling & Donner, 2009). Although still primarily used as telephones, most of the handset devices currently found in these environments are in truth digital media clients capable of exchanging data through SMS texting, and many also support at least rudimentary Web browsing.
• Electronic Transfer of Funds. The best known example of electronic transfer of funds in an emerging market is the M-PESA system in Kenya (Hughes & Lonie, 2007). While the model has been introduced with less success in other markets, it can be assumed that what is lacking is the compelling use case for adoption. Access to a wide range of goods at lower prices through ecommerce might be just that use case.

The fulfillment component of an ecommerce business model could prove more challenging in many markets than the sales and payment components. Transportation infrastructure can be poor, and failures in governance can lead to lawlessness and banditry. Prahalad discusses how two Latin American companies, Brazil’s Casas Bahia and Mexico’s Bimbo, have established community trust that allows their delivery vehicles unmolested access to slums where police dare not go, and in Bimbo’s case gives their drivers access to local stores’ cashboxes when the owner is not present. A startup ecommerce venture would have to earn this level of community trust, but with proper introduction and partnership, it seems possible to partner with already trusted distribution networks in many markets, be they trucks operated by Bimbo, or the local “chicken bus” that makes regular runs to the closest city.

Usability Challenges

Simply because a mobile phone can display a Web page, we can’t assume that the user experience is going to be adequate to completing the task at hand. Building an ecommerce interface for emerging markets not only requires adapting to the requirements of a small form factor interface and a relatively slow network, it means understanding and adapting to user needs.

Common ecommerce Web site interfaces rely heavily on text-based hierarchies of product categories, providing an alternate user point of entry through text-based search. But in a market where the target customer may have limited, or no, literacy text-based interfaces will be ineffectual.

Interface researchers working with non-literate populations in India have shown that success in some narrowly-defined tasks can be achieved with iconographic interfaces (Mehdi, Sagar, & Toyama, 2007). Basic ecommerce tasks, including browsing product hierarchies, could adapt well to iconographic interfaces. However, the limitations of mobile phone displays and cell networks could make implementation of a graphics-intensive interface impractical.

Another interface alternative is suggested by work on speech-powered interfaces (Plauché & Nallasamy, 2007). However a large product catalog may prove impractical to browse through a complex voice menu system.

Given the challenges of usability given current technology, it may be that in many markets the practicality of a nationwide ecommerce system is still a few years out, relying either on hardware and network upgrades, possibly including adoption of laptops by the target customers. In Latin American countries or other areas where literacy rates are high, a text-based mobile interface could be practical now, but these countries also tend to have more developed retail business, making for a more competitive environment for an ecommerce startup.

Applying the Co-op Model on Top

It can’t be stressed enough that, whatever lofty intentions may get attached to co-ops, they are all at heart for-profit enterprises. The co-op model just ensures that the profit is used to benefit members. The specific charter of a co-op determines how that benefit is expressed: in some co-ops it is returned directly as cash or store credit, in others it is used to lower costs.

Creating an ecommerce business as a co-op with to pass profits on to members in the form of lower costs takes the efficiency gain of ecommerce up a notch. In an ideal situation, the more members the co-op attracts the more purchasing power is available to lower per unit costs when buying wholesale, which lowers retail cost to members, while the overall profit of the co-op increases and is applied to further reducing costs.

The Importance of Co-op Governance

The co-op charter also can provide the framework for enforcing good governance on the business. Founding co-op board members typically come from the ranks of co-op members and subsequent board members are nominated by the co-op’s membership. Locally however, this is no longer the case at either REI (Ryan, 2003) or PCC (personal conversation with PCC board member, 2009). In both companies, board members are now nominated by sitting board members. This has been the source of some amount of concern among REI members. (I am unaware of similar concerns among PCC members, but may have just not been exposed to them.)

Perhaps this is a natural progression that must happen as co-ops reach a certain size, but in countries where poor governance and corruption have been major contributors to the lack of development (Collier, 2007) it is essential that changes in co-op charter be done transparently and with full member awareness. The frustration with REI is perhaps less with the change in charter than with the fact that it appears to have been implemented by a past board with so little visibility that even REI itself could not answer a reporter’s request for the year in which the change occurred. This suggests to some that REI might be out of compliance with co-op principle 2: “Co-operatives are democratic organisations controlled by their members, who actively participate in setting their policies and making decisions…” (ICA, 2007).

In a country where mistrust with government and business is stronger than it is in the United States, and with good reason, a situation like that could be enough to cause widespread membership abandonment and destroy the business.

The Pitch for Developing a Business Plan

I’ve come to think of co-ops in general, and this plan in particular, as something of an open-source business model. A framework has been created, and now it’s available for download to be applied in any market where it might be useful. Like open-source software, the success of the project depends on having developers who keep contributing back into the framework, making it better in response to real-world conditions.

What I propose is that a startup could be formed by experienced ecommerce and co-operative business thinkers in developed countries. This startup (which might well be a co-op itself) would take the open-source co-op framework to promising markets, fund the initial startup costs of the co-op, recruit local talent to establish the necessary relationships for sales and fulfillment, and oversee the first years of the co-op’s life as founding board members, alongside board members voted in by the local co-op membership.

At an appropriate point, these founding board members would be replaced entirely by local members. The outside startup could continue to offer consulting services to the co-op, or the co-op could choose to sever the ongoing relationship and only be obligated to repay the startup for work done and costs incurred in founding the co-op.

In this way, I propose that Prahalad’s vision of eliminating poverty through commerce could be improved upon by swapping out the inefficient middle tier of distribution, with its multiple levels of profit taking, and inserting a co-operative model which is explicitly charged with decreasing costs and increasing it members’ standard of living.

Appendix I: ICA Principles

Copied from ICA, 2007.

Statement on the Co-operative Identity

Definition

A co-operative is an autonomous association of persons united voluntarily to meet their common economic, social, and cultural needs and aspirations through a jointly-owned and democratically-controlled enterprise.

Values

Co-operatives are based on the values of self-help, self-responsibility, democracy, equality, equity and solidarity. In the tradition of their founders, co-operative members believe in the ethical values of honesty, openness, social responsibility and caring for others.

Principles

The co-operative principles are guidelines by which co-operatives put their values into practice.

• 1st Principle: Voluntary and Open Membership
  

  Co-operatives are voluntary organisations, open to all persons able to use their services and willing to accept the responsibilities of membership, without gender, social, racial, political or religious discrimination.

• 2nd Principle: Democratic Member Control
  

  Co-operatives are democratic organisations controlled by their members, who actively participate in setting their policies and making decisions. Men and women serving as elected representatives are accountable to the membership. In primary co-operatives members have equal voting rights (one member, one vote) and co-operatives at other levels are also organised in a democratic manner.

• 3rd Principle: Member Economic Participation
  

  Members contribute equitably to, and democratically control, the capital of their co-operative. At least part of that capital is usually the common property of the co-operative. Members usually receive limited compensation, if any, on capital subscribed as a condition of membership. Members allocate surpluses for any or all of the following purposes: developing their co-operative, possibly by setting up reserves, part of which at least would be indivisible; benefiting members in proportion to their transactions with the co-operative; and supporting other activities approved by the membership.

• 4th Principle: Autonomy and Independence
  

  Co-operatives are autonomous, self-help organisations controlled by their members. If they enter to agreements with other organisations, including governments, or raise capital from external sources, they do so on terms that ensure democratic control by their members and maintain their co-operative autonomy.

• 5th Principle: Education, Training and Information
  

  Co-operatives provide education and training for their members, elected representatives, managers, and employees so they can contribute effectively to the development of their co-operatives. They inform the general public – particularly young people and opinion leaders – about the nature and benefits of co-operation.

• 6th Principle: Co-operation among Co-operatives
  

  Co-operatives serve their members most effectively and strengthen the co-operative movement by working together through local, national, regional and international structures.

• 7th Principle: Concern for Community
  

  Co-operatives work for the sustainable development of their communities through policies approved by their members.

References

BECU. (n.d.). BECU is your community credit union. Retrieved from http://www.becu.org/who-is/history.aspx

Childs, M. W. (1936). Sweden; The middle way. New Haven: Yale University Press.

Collier, P. (2007). The Bottom billion: why the poorest countries are failing and what can be done about it. New York: Oxford University Press.

Crowley, W. (2000, January 1). Group Health Cooperative of Puget Sound incorporates on December 22, 1945. Historylink.org- the free online encyclopedia of washington state history. Retrieved (2009, November 4) from http://www.historylink.org/index.cfm?DisplayPage=output.cfm&file_id=2747

Hughes, N, & Lonie, S. (2007, August 2). M-pesa: mobile money for the “unbanked”. innovations, Retrieved from http://www.policyinnovations.org/ideas/innovations/data/m_pesa

International Co-operative Alliance (ICA) (2005, July 21). Co-operative history. Retrieved from http://www.ica.coop/coop/history.html

International Co-operative Alliance (ICA) (2007, May 6). Statement on the Co-operative Identity. Retrieved from http://www.ica.coop/coop/principles.html

Ling, R, & Donner, J. (2009). Mobile communication: digital media and society series. Polity Press.

Medhi, I., Sagar, A., & Toyama, K. (2007). Text-Free User Interfaces for Illiterate and Semiliterate Users. Information Technologies and International Development. 4 (1), 37-50. Retrieved (2009, November 4) from http://research.microsoft.com/en-us/people/indranim/text-freeui.pdf

Oldham, K. (2007, July 8). Port Angeles — Thumbnail History. Historylink.org- the free online encyclopedia of washington state history. Retrieved (2009, November 4) from http://www.historylink.org/index.cfm?DisplayPage=output.cfm&File_Id=8210

PCC, . (n.d.). About Pcc . Retrieved from http://www.pccnaturalmarkets.com/about/index.html

PEMCO. (n.d.). PEMCO About Us – History. Retrieved from http://www.pemco.com/about_us/details/history.aspx

Plauché, M., & Nallasamy, U. (2007). Speech Interfaces for Equitable Access to Information Technology. Information Technologies and International Development. 4 (1), 69-86. Retrieved (2009, November 4) from http://portal.acm.org/citation.cfm?id=1345092

REI (n.d.). The REI story. Retrieved from http://www.rei.com/jobs/story.html

REI (2008, December 31) Consolidated Balance Sheets. Retrieved (2009, November 4) from http://www.rei.com/pdf/aboutrei/2008REIFinancialStatements.pdf

Ryan, A. (2003, June 18). Who Owns REI?. Seattle Weekly, Retrieved from http://www.seattleweekly.com/2003-06-18/news/who-owns-rei/1