Written by: Kok Yu Xiang, 15 November 2020

Photo by Ny Menghor on Unsplash

*Opinions expressed in this article are strictly my own and do not represent that of any entity or organization. Please drop me a note at yuxiangkoksg@gmail.com if you spot any errors or inconsistencies.

Underserved and rural markets (also broadly referred to as lower-tier markets in this article) present an exciting yet challenging opportunity. As “consumer-friendly” market segments in tier 1 and 2 cities become saturated, lower-tier cities are the next area of growth for incumbents and hotbed of innovation for start-ups. However, the different needs and wants, lower spending power, and lack of logistic infrastructure remain big obstacles in successfully penetrating these lower-tier markets. It is important to recognize the unique characteristics of lower-tier markets and provide well-thought solutions that may end up being vastly different from something that worked in developed markets.

Arguably, the biggest hurdle of going after lower-tiered markets is the lower income level and spending power of households and consumers. In less affluent markets, consumers are likely more price sensitive and the perceived value of products is heavily influenced by affordability. Lack of infrastructure and logistic difficulties only add to the cost of serving lower-tiered markets.

From a product and service standpoint, to be successful in penetrating lower-tiered markets (especially rural communities), the business needs to either (i) provide goods and services at an affordable and cheaper price in comparison to existing alternatives, (ii) and/or provide goods and services that have some form of productive use and enable the consumer to increase their income/wealth over time. For the purpose of this article, the examples highlighted will mainly cover companies in the agriculture sector or companies with solar solutions that are providing access to energy for rural and underserved markets.

From a business model standpoint, the more successful businesses seen in rural and underserved markets involve:

Providing Financing Options - The most popular form of financing is the Pay As You GO (PAYGO) model, also commonly known as lease-to-own or rent-to-own. Under the PAYGO model, consumers pay monthly installments for the use of a product until they successfully pay off the initial loan given to them for purchasing the product. The initial loan usually comes from tie-ups with microfinance institutes or from a credit facility managed by the company selling the product. PAYGO is commonly seen in the sales of pricier products like solar systems where the consumer has a payback period of between 2-5 years before eventually owning the solar asset. To ensure timely payments, the solar asset is typically set-up in such a way that it shuts down automatically if the consumer fails to make payments. In the case of solar solutions targeted for agricultural uses, the payment terms can be tied in with the harvest cycles of the crops planted by the farmers to ease the financial burden on them. The whole idea behind PAYGO is to split high upfront cost into affordable blocks and since then, PAYGO has evolved with innovative payment terms that reduces the risk of defaults. The PAYGO model was first tested in East Africa through solar companies like M-KOPA and Mobisol before being adopted in Asia through companies like SolarHome.

The concept of allowing consumers to delay upfront payments and spread it over months is also seen in the education space with Income Share Agreements (ISAs), a type of financing where a student pays for the tuition fee with a percentage of their income after graduation. While inherently risky, financing for lower-tiered markets is necessary for businesses to avail their products or services to a wider number of consumers in markets where the majority of consumers do not have the spending power seen in developed cities.

Competing on Price - While emerging consumers aspire to buy branded and quality products since the financial loss from an underperforming product is greater for consumers with limited income, affordability still remains a key concern. The rise of Pinduoduo in recent months is the best example of a business that successfully competes on price. 55% of Pinduoduo users are from tier 3 or below cities in China and the largest appeal of PDD is the group buying function (the more people buying the lower the price). Procurement in bulk allows businesses to purchase at cheaper prices and lower logistic costs, from which cost savings can be passed on to consumers. This is typically done through demand aggregation or setting up clusters/hubs for greater cost efficiencies in warehousing and delivery. Agriculture cooperatives or farmers’ co-op are other examples of pooling demand and resources to enjoy economies of scale. Constantly innovating to improve margins and being equipped to compete on prices are critical considerations for businesses in lower-tiered markets.

Demand aggregation is a high-volume low margin strategy. In most cases, demand aggregation alone will not be a viable solution for business to generate enough revenue and a “sponsor” is needed. In the case of PDD, the “sponsors'‘ are corporates and clients paying for advertising on PDD’s platform, indirectly subsidizing the low margins from sales (90% of PDD’s revenue came from online marketing services). In the case of solar companies, the “sponsor” is often the government who offers subsidies, tax rebates and public-private partnerships.

Lower-tiered markets are difficult to crack. However, these often fragmented markets offer the greatest opportunity for growth and calls for innovation across the entire value chain. Lower-tiered markets also requires greater consideration of the implications on consumers, where growth is not determined by marketing spend but by the value created for users at the bottom of the pyramid. If you are a start-up operating in Southeast or South Asia, especially in the clean energy space, I would love nothing more than to hear from you!