Innovating in emerging markets: Estimating a customer’s willingness to pay
The key is to innovate with nonconsumers’ needs in mind, and step one is determining what they can afford to pay.
Before 19th century American innovator and businessman, Isaac Singer, developed an efficient sewing machine for the masses, experts at the time told him his business would fail. Similarly, when Henry Ford decided to make a car affordable to the average American, several of his investors pulled out of his company because they didn’t see how Ford could succeed. Cars, at the time, were like private jets and were limited to only the wealthy. In our research, we call their innovations market-creating innovations. These powerful innovations make products simple and affordable so many more people in society – nonconsumers – can afford them.
Singer and Ford are not alone in the feelings of disbelief they propagated when they decided to develop market-creating innovations. Innovators from Akio Morita of Sony to Mo Ibrahim of Celtel had a similar experience when they decided to create new markets that served nonconsumers, especially in economically poor regions. One of the primary reasons was the assumption that nonconsumers couldn’t afford the new products introduced to the market.
Today, however, we know these reservations were misplaced. By serving nonconsumers, each of these innovators went on to create new markets that not only benefited their respective organizations, but society at large as resources, infrastructure, and human capital were pulled in to support the fledgling industries.
It turns out that in emerging economies, the population of nonconsumers for most products is so vast that profits can be made even when nonconsumers are able to pay far less than traditional consumers. The key is to innovate with nonconsumers’ needs in mind, and step one is determining what they can afford to pay. To that end, how can innovators get a good idea of what nonconsumers can afford to spend?
Step 1. Select a few economies in which a product has widespread consumption, and collect data on these markets.
Application: Let’s say we’re interested in developing a mobile telecommunications solution, and are able to collect data on what consumers spend annually in Canada, Chile, Germany, Italy, South Korea, and the USA.
Step 2. Calculate the average percent of income spent on consuming the solution in these economies. We can use Average Annual Revenue Per User (ARPU) divided by GDP per capita as a proxy.
Application: Based on the data provided in row 3 of the above table, the average percent of income that consumers in mature markets can spend is 0.85%.
Step 3. Approximate what a nonconsumer in an emerging market can spend on the solution using the “percent-of-income” estimate calculated in step 2:
Application: Let’s say we’re interested in the following emerging markets: Ghana, India, Kenya, Laos, Nigeria, Pakistan, and Uganda. Based on the data provided in the table below, we multiply GDP per capita (row 1) by 0.85% (from step 2). Row 2 approximates what nonconsumers can spend annually on a mobile telecommunications solution in each country.
By that simple calculation, innovators can begin to get an idea of the average nonconsumer’s willingness to pay. Although the amount may seem miniscule in comparison to what consumers in wealthier countries pay, the potential for market creation is enormous. Consider Nigeria as an example.
In the late 1990s, mobile telecommunications entrepreneurs such as Mo Ibrahim of Celtel wouldn’t be dissuaded by colleagues who couldn’t see the market potential of setting up a mobile phone company in Africa. He knew that if he could make telecommunication simple and affordable, nonconsumers would embrace it with open arms – and he was right. In 2018, the mobile telecommunications market in Nigeria was estimated at almost $5 billion, up 15% from the previous year.
Pricing your product
The above back-of-the envelope calculation is meant to provide innovators with a starting point, but it’s important to recognize that spending patterns vary. For instance, after studying the affordability of several products and services (beef, chicken, mobile telecommunications, Internet, local transport), we uncovered some interesting insights. On average, people in low- and lower-middle income countries spend up to 7.5-times the percentage of their incomes for products than people in high-income countries, while people in upper-middle income countries pay around 2.2-times their income. As products become more affordable to the wider population, the percent of income spent on the product seems to reduce dramatically.
It’s difficult to know exactly how much customers will be willing to pay before releasing a product to the market, especially if there is little to no available data. It’s the innovator’s task to approximate what they think nonconsumers can spend, come up with creative ways to reduce costs and other barriers, and iterate as they learn more. Our research suggests that it’s well worth the effort – not only will they unlock powerful new growth opportunities, but they’ll help create a market that has the potential to transform societies.
Efosa Ojomo is a senior research fellow at the Christensen Institute, and co-author of The Prosperity Paradox: How Innovation Can Lift Nations Out of Poverty. Efosa researches, writes, and speaks about ways in which innovation can transform organizations and create inclusive prosperity for many in emerging markets.
The article is published under the editorial partnership between Financial Nigeria and the Clayton Christensen Institute, to promote market innovation.
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