Apparently, to be a successful “public intellectual” one of the requirements is that one must invent a catchy tag line. The tag line must have emotional appeal through a reference to some deeply held belief or social conditioning. An example of one such is the title of the book by Thomas Friedman “The World is Flat” which attempts to upset your view of the world that it is round. Another example is “the fortune at the bottom of the pyramid” which the obvious connection to the phrase “the pot of gold at the end of the rainbow.”

C. K. Prahalad is one of the most influential management gurus in the contemporary world and the co-author of the book “The Fortune at the Bottom of the Pyramid” (2004). He has a cult following of mythic proportions among certain segments of the managerial class. I have to confess that I have not been too persuaded by the arguments of that book because I have difficulty squaring the “BOP” proposition with my understanding of basic economics. So it was a pleasant surprise when I read Aneel Karnani’s (Ross Business School at the University of Michigan) working paper of July 2006 “Fortune at the Bottom of the Pyramid: A Mirage” (free download) [Hat tip: Raja Sekhar Malapati.]

Karnani’s paper argues against the BOP proposition. He summaries the BOP proposition as: there are profits to be made by selling to the billions of the world’s poor, and by doing so, bring prosperity to them, thus alleviating poverty, and that multinational corporations (MNCs) should sell to the poor to do good while doing well for themselves.

First there is the disagreement regarding the actual size of the BOP market. The BOP camp estimates that the potential market at PPP terms is US$13 trillion. Karnani estimates a more modest US 1.2 trillion at PPP, and more like US$ 0.3 trillion at the financial exchange rate. That’s an order of magnitude difference there.

Furthermore, Karnani points out that the poor spend most of their income on food; the poor have little disposable income. Therefore, if their incomes don’t rise, they cannot afford to consume more than they actually do. If there are ways of making stuff more affordable to the poor, it is certainly not by selling stuff in smaller packages. Smaller packages in fact have a higher unit cost, not lower. Pretending that smaller packages increase affordability is similar to pretending that selling food in very small packets will solve the hunger and malnutrition problem of the poor. He concludes that the “single serving revolution is a dud.”

The paper takes Prahalad to task for giving examples which do not demonstrate that MNCs do, or even can, sell to the poor. The markets which the poor engage in don’t permit scale economies. Therefore the poor are better served by local small and medium enterprises, argues Karnani.

The poor, he says, are forced to make a different cost-quality tradeoff. They would rather have a more affordable but lower quality good than a higher quality good which is out of their reach. He says that the claim that MNCs can reduce their prices dramatically without sacrificing quality is unrealistic.

Rather brutally, Karnani declares that the “fallacy of the BOP proposition is exacerbated by its hubris”:

Prahalad (2004) states that all the examples used in his book challenge the current paradigm. Selling appliances on credit – as does Casas Bahia – is not even a nobel idea, let alone a new paradigm. But, Prahalad is not content with changing paradigms, and asks us to change “our genetic code”!

The Millennium Development Goals adopted by the UN member states targeted halving of extreme poverty in 25 years. Finding this pace too slow, Prahalad states “I have no doubt that the elimination of poverty and deprivation is possible by 2020.” But why be satisfied with only poverty eradication when so many other problems plague the world? Prahalad and Hammond (2002) argue that the BOP initiative will not only eradicate poverty, but also cure economic stagnation, deflation, governmental collapse, civil wars, and terrorism. And all this in 15 years!

While providing credit to the poor for purchasing high-priced items (Casas Bahia example) makes them worse off because of the burden of additional debt, Karnani agrees that microfinance is a good example of how the poor can be helped. But even there he is cautious and notes that most microfinance institutions are non-profit entities, and are not self-supported.

Karnani denies that the BOP claim that there is untapped purchasing power at the BOP. He says that the way to help is to raise the real income of the poor. The poor must be seen as producers, rather than as consumers. That is, buy from the poor instead of selling to them. He cites Amul and ITC e-Choupals as examples of more efficient markets–where the poor are the producers—that increase real incomes. And if you have to sell to the poor, then make available lower quality goods which can be priced lower so that the poor can have greater choice along the price-quality spectrum.

Is the BOP proposition a harmless illusion or a potentially dangerous delusion, he asks. He argues that the BOP initiative results in the poor spending money on products such as TVs and shampoo that would have been better spent on higher priority needs such as nutrition, education and health. “The problem is that the poor often make choices that are not in their own self interest.”

My position is that it is not only the poor but all people often make choices that are not in their interest. The only distinction is that the rich can afford to make poor choices, which the poor cannot. At least some of the stuff that I buy is not really useful, and often times is positively harmful. But I have much more than $2 a day, and can afford poor choices.

I agree with Karnani that you have to increase the real incomes of the poor by seeing them as producers. This I believe can be done by two ways. First, the “distribution” route: produce (possibly more) stuff, and give them a larger share. This lump-sum transfer will increase their real incomes. Second, the “production” method: help them produce more and also become more productive. The former is unlikely to appeal to the rich.

To do the latter, you have to make markets for the production of the poor more efficient so that they retain more of the value they produce. To make them capable of producing more, you have to educate them. There is where I believe the fortune at the bottom of the pyramid lies. Education has positive returns in today’s world. The return on investment in education is positive. That means, the cost of the education will be more than paid for by the subsequent increase in the real income. But the poor are credit-constrained. So the way to help the poor is to release that credit constraint through financing education. How to do that is a different kettle of fish which we will leave for a later date.