Thinking sustainable profits
Profits are a necessary condition for the success of an enterprise, and sustainable profits are crucial to the success of any long-term development project. "Think sustainable profits" is a key principle to guide the work of social entrepreneurs who serve the needs of artisans, small farmers, shepherds, street vendors and many other classes of small producers around the world. Sustainable profits go beyond economic measurements to focus first on those who will achieve social change – the individual clients and their communities – as well as the resources and market opportunities available to them. In this context, social entrepreneurs become facilitators, and many times also leaders, of a long-term development process.
Building sustainable systems to deliver services to small producers is a challenge. Sustainability is not only a problem for small producers, it also depends on social entrepreneurs' ability to deliver services to the producers over time (e.g., their ability to recover the cost of delivering needed financial and technical assistance). This is an area where learning is still occurring. While best practices are emerging, practitioners and social entrepreneurs alike still are working to fully understand the complexities associated with generating sustainable profits when serving the poor.
Thinking Sustainable Profits
Professor Roland Christensen of Harvard Business School used to say that good managers spend 80 percent of their time finding out what are the right questions, and only 20 percent of their time answering them. The questions in this discussion are not ones with right and wrong answers. They are issues that anyone who wants to promote sustainably profitable businesses must address in the context in which he or she is working. Like the people they are trying to help, these social entrepreneurs are risking their own time and money, in the hope of achieving certain objectives. Unlike their "clients," however, they are doing this not to earn a living for their families, but to help others who are less fortunate than themselves. In many ways, this is even more difficult.
Let us clarify what we are talking about; what do we mean by "profits," and "sustainable"? Then, whom are we trying to help, and how? Finally, what about the "social enterprise;" the agency through which we work? What sort of institution should it be, and who should own and pay for it? If readers can answer all or even a small number of these questions, for their own situations, this introduction will have achieved its objective.
What is "Sustainable," and What are Profits?
First, what is "sustainable"? It is a fashionable word, and like many such words we often use it to conceal from ourselves and others that we are not clear what we mean. If a beggar on the street in Nairobi knows how to pay off the police, and gets enough money every day to stay healthy, is his business sustainable? If an NGO in Kampala is clever enough to persuade donors to continue to finance its projects, regardless of how beneficial they are to those who are intended to benefit, is it sustainable?
And, is sustainability just about money, or does it mean more? Is a backyard tannery near Lucknow sustainable if it pollutes the water system, even if nobody will ever complain? Or is a family carpet weaving business in the hills in Nepal sustainable if children do the work, so that they cannot attend school?
We all come across such cases, and we cannot always argue that these "environmentally" or "socially" unsustainable businesses are also unsustainable in business terms. There is little chance that the local government, or the community, will get around to enacting or enforcing stricter standards. Everyone has to clarify what "sustainable" means, for himself and his institution. We cannot use the vagueness of a word as an excuse for avoiding critical issues. Official generalized definitions are of little help in specific situations. As in all the questions that follow, we must try to balance the realities of the situation as we find it, and to decide whether the immediate benefits gained by the owner of the business and her employees outweigh any long term damage which it is causing to themselves or to others.
And what are "profits"? Technically, they are what remains after a business has covered its costs; they represent the return on the owners' investment. This return covers the "opportunity cost" of the money that is invested, and the risk of loss. In the context of micro-enterprises, it is more useful to think of profits as any surplus that may remain after the owner has withdrawn enough money to cover her household needs, although this of course begs the question of what these needs may be. We must, however, be clear that profits are necessary. Without them, a business cannot grow, and it cannot survive even a temporary downturn.
Financial analysts and economists compare one business with another by calculating the percentage of profit on the investment. The annual profits earned by successful large corporations may be as much as 30 percent or 40 percent of the sums invested in them. The return on the micro-investments in micro-businesses, however, is usually astronomic, since the investment may be no more than $10. Even a profit of a $1 a day represents an annual return of over 3,000 percent on this. This does indeed show us that such micro-investments are an excellent way of using a country's or a household's resources, and are much more productive than most large private or public undertakings, yet such comparisons are not much use for day-to-day micro-enterprises.
Perhaps we should keep it simple, and forget the rather artificial separation between the owners' wages and any reinvested surplus. If profits plus wages (since most micro-business people do not distinguish between the two) are enough to enable the owner's family to survive and to allow a small margin for emergencies or growth, that is enough. But then I think of Nasr-el-Din, an 11-year-old boy selling plastic bags who I met in a Khartoum market. He was earning 40 cents a day on the 20 cents capital his mother lent him each morning. Was that "sustainable profit"? And should the local government, like some authorities in India and elsewhere, forbid the sale of the low-cost plastic bags he was selling, because they could not be recycled? Again, there are no easy answers.
And when we come to the social enterprises, should they make profits at all? I myself believe they should, since they will otherwise only last as long as their founders' enthusiasm and their donors' goodwill, but there are no right and wrong answers; change-makers must make their own decisions, and ensure that they are embedded in the culture of organizations which they lead.
Whom are We Trying to Help?
How can small businesses be sustainably assisted by social enterprises... I deliberately use the word "business" to describe the clients whom social entrepreneurs want to help, to emphasize that the aim is to help people to make a living by adding value, by using their initiative and effort to sell things for more than they cost.
But there are many kinds of business. If as social entrepreneurs we are effectively to assist them, we must be business-like ourselves. We must carefully define our market segment, those business owners who most need our help, and whom we can most efficiently reach. There are many options. All may be deserving, but if we try to reach them all we shall fail to reach any; we have to focus our efforts where they can be most effective.
Should we aim to reach women, or men, or both?
If we open our doors to both, we shall probably have a mainly male clientele, since men usually get the first place in any queue. Should we discriminate in favor of women? There are many arguments in favor of this; women save and repay loans more reliably, they work better in groups, and they spend their earnings on their families and not on liquor. And, women are usually disadvantaged socially and economically; they need our help more than men. If our aim is to recover small loans, and to help large numbers of families to survive through self-employment, we should do as most microfinance banks and NGOs do, and focus on women.
But, women are usually less ambitious, and household pressures may force them to stop their businesses. There are of course examples of women who have successfully started and built businesses that employ hundreds or thousands of other people, but they are in the minority. If we want to change society, we should perhaps try to identify and assist such women. But if our aim is to create jobs as cost-effectively as possible for the vast majority of men and women who would prefer to get a job than to create one, maybe we should focus on men. We have to decide.
Should we help the informal micro-businesses of the poor, or should we work with more formal "modern" small businesses?
Economic growth and development, insofar as we can judge from what we see around us, is based mainly on employment rather than self-employment. Millions of very poor people survive through micro-businesses, but in every "developed" economy the majority of the population are employed; are we really contributing to sustainable development if we assist only survival businesses?
Sadly, there seems to be little short- or medium-term prospect that the vast numbers of the poor in most so-called "developing" countries will get jobs. Many 'developing' economies are either not developing at all or are becoming ever more inequitable. Social entrepreneurs usually want to help people who need help, quickly. Subsistence self-employment will probably be the only option for the poorest people for many years to come. We must however recognize that these micro-businesses will never enable their owners and their few employees to enjoy the same standards as the middle class in their own countries, or the majority of the population in the more developed countries. Microenterprise development may be a cost-effective and sustainable form of poverty alleviation, but it is not a route even to modest well-being as perceived by the average European or North American.
Should we assist traders, or only "producers"?
This issue of Changemakers is about "producers," and those who assist them. We must, however, be clear as to why and whether we should exclude traders. Many development programmes try to "eliminate the middleman," and to help producers to earn more for their labor. At the same time, however, many clients of microfinance are themselves middlemen, or rather middle-women, such as market women, vendors and so on, and trading is the easiest entry point, particularly for the poorest people, with no land, or training. About a quarter of the micro-loans made by the Grameen Bank in Bangladesh, for instance, are used to finance petty trade, and the proportion of so-called "non-productive" loans made by microfinance institutions in Africa is much higher. The borrowers produce nothing in the physical sense; they sell things that others produce.
Adam Smith said that tradesmen "can never be multiplied so as to hurt the public, though they may so as to hurt one another." If we assist more people to sell the same goods to the same market, are we doing any more than cutting the same cake into ever-smaller slices? This would by definition be unsustainable.
On the other hand, trading adds value just like processing or growing; only a few farmers and artisans can sell their products direct to consumers, and they need channels through which to market their goods just like any firm. One of the main problems of small producers is their lack of markets. Traders help producers to reach new markets, and carefully targeted assistance for a few wholesale or retail traders may be the most effective way to help large numbers of small producers. We should look at the prospects of the business, and the needs of those who work in it, rather than judging that certain types of business are "good" while others are not.
Should we help to start new businesses, or only those who are already in business?
If we want to help the neediest, we should work with people who have little or no earnings of their own, and are dependent on family members or charity for survival. They may lack energy, capital, skills or the motivation to start something of their own, and there are large numbers of business start-up and entrepreneurship development programs that try to help such people to start businesses. On the other hand, not everyone can start a new business, even with lots of help, and the best way to identify those who do "have what it takes" is to find people who have already started something, however modest it may be.
Very few "start your own business" programs achieve more than a 30 percent success rate. Might it not be more sustainable and cost-effective to work with people who have already passed the first test, and to help them strengthen their businesses so that they do not fail, and may in time grow larger and employ others? We should only help beginners if there are no existing businesses whose owners can make use of our help.
How Should We Try to Help Them? Should we work with groups or individuals?
Co-operatives and group businesses have a bad record; some succeed, but most are institutionally unsustainable, particularly when well-meaning outsiders assist them. There are of course some dramatic exceptions, and every Indian knows of the success of "Operation Flood," which has revolutionized much of the Indian dairy industry through the successful promotion of large numbers of co-operatives of small producers, mainly women who own only one or two cows. It is sadly true, however, that everyone refers to the same examples. Economic growth, employment and development have mainly been the result of individual initiative, everywhere, and very few business development agencies nowadays insist or even recommend that their clients should work together. The Grameen Bank started operations in 1976 and at first the majority of its loans were for group businesses. By 1990 only about 3 percent of the money disbursed was used by groups, and by 2000 the figure was under 1 percent.
Many microfinance and other business assistance agencies still work through groups, however; they expect their clients to save and borrow together, to learn together and even to buy or sell together. There are obvious reasons for this. It is cheaper to reach people in a group than as individuals, the group members may support each other, and non-economic goals, such as social and political empowerment, depend on group solidarity.
But we must not forget that individual initiative is the driving force behind business, and very few of "us," the readers of this publication, would like to do our banking in groups. We should not make the mistake of thinking that "they" are so different from "us." The world's biggest and most profitable microfinance operation, the village unit program of the National Bank of Indonesia, does not use groups of any kind, its clients save and borrow as individuals. This program has some 15 million savers and around 4 million borrowers; it is also the most profitable part of the country's largest commercial bank. We should not assume that group working is more convenient for our clients because it is more convenient for us. The best rule is to deal with people as individuals whenever possible. Groups should only be used if there are strong economic or social reasons.
Should we provide loans, or other business development services?
Some microfinance organizations, such as the Grameen Bank of Bangladesh, provide only financial services. They train their clients in the procedures which the bank requires, but they do not offer training or advice. They rely on their clients to decide what to do, and to do it.
Other organizations provide business ideas, training, marketing and material supplies, and they may also try to influence the "policy framework," to persuade local and national governments to stop harassing micro-businesses and to remove the other regulatory constraints which may be far more serious than lack of capital or skills.
Large multinational businesses stick to their "core business." Should business promotion agencies not identify their "core competence," the thing they do best, and focus on that alone? Or, should they provide everything their clients need? There are arguments on both sides, but most successful agencies concentrate on one service. They may refer their clients to different organizations for other services, and they may even help some of their own staff to set up such organizations, but they themselves do one thing, and do it well.
The "Social Enterprise" that Provides the Assistance
Should it be an NGO, a business, a cooperative, a government office, or what?
It is often easier to decide what to do than to decide what institution should do it. NGOs are the usual choice for social development entrepreneurs, but is it logical for a non-profit institution to promote sustainable profitability? Sometimes, it may be better to start a community business, which is responsible to the people whom it is intended to benefit. This may be uncomfortable for the initiator, particularly if they demonstrate their sustainable empowerment by throwing him out.
It is unfashionable to suggest that governments can promote change, but an individual government servant, who takes the word "servant" seriously, can often do more to promote sustainable livelihoods than any NGO. Or, a private profit-maximizing business may be the best instrument. Soft drink manufacturers help thousands of unemployed people to become self-employed street vendors; their motive is profit, but they may reach larger numbers, more sustainably, than any selfless social entrepreneur ever could. And socially-inclined entrepreneurs might do more for the poor, more sustainably, by profitably buying their products, or selling their products to them, than by setting up an NGO. They have to decide.
And who should pay for it?
It is unusual to think of micro-business development as a sustainably profitable business in itself. It is usually paid for by donors, either foreign or local, or by governments, and many people also donate their time.
Many charities (I prefer this word to the anonymous acronym "NGO" which only says what the institution is not) have survived and grown for a long period by successfully fund-raising. Donations and subsidy, however, are inherently unsustainable, and are also inconsistent with the promotion of business. Businesses expand because they can make more profits that way, but an institution which depends on subsidy or donations can only expand by getting more of the same. True sustainability can only be attained by charging fees which cover all the costs, and making a profit (or "surplus," NGOs often avoid the word "profit," just as they use "coordinator" instead of "head") to build resources for the future.
If there is going to be a long term need for the service you provide, and you want your social enterprise to continue to satisfy it, you should try to find a way in which it can be a profitable business in itself. If the job is one which can be completed quite soon, however, or if you think that the enterprise will always be able to raise donations and subsidy, long after you yourself have left it, then you need not worry about sustainability in the business sense.
Instead of giving answers, this article has instead posed some of the issues which anyone who wants sustainably to promote sustainably profitable micro-enterprise must face. I have deliberately skewed some comments in favor of less obvious alternatives, in order to prompt readers to figure out for themselves why we may be wrong.
The following are my personal views, and, as I have suggested above, some or all of them may be quite wrong in particular cases or for particular readers. There is no substitute for personal decisions.
Dr Malcolm Harper is the author of ten books and many articles on business development in the Third World that have made him one of the best-known experts in the field of small enterprise development. He is Professor Emeritus at the Cranfield School of Management, Cranfield University, UK. Dr. Harper holds an MA (Oxford), MBA (Harvard) and a PhD from the University of Kenya. His books include "Profit for the Poor" (UK, 1998), "Value for Money? Impact of Small Enterprise Development" (UK, 1998) and "Getting Down to Business: A Training Manual for Business Women" (UK, 1992).
Valeria Budinich was brought up in Chile and trained as an industrial engineer. She has worked as Chief Operating Officer for EnterpriseWorks Worldwide, where she assumed a leading role in the development field's thinking regarding small producers. She helped launch Ashoka's sister organization, Endeavor, in Chile and beyond. Ms. Budinich has worked a technical adviser for Woman's World Banking, an organization dedicated to helping women around the world succeed in business, as well as many other international organizations specialized in small enteprise development.
For further information on microfinance, readers may care to look at the case studies on Grameen Bank, the National Bank of Indonesia (BRI) and others in Harper M., "Profit for the Poor," Oxford and IBH Publications, New Delhi, and ITDG Publications, London, 1998.
This article was adapted from material that comes to India Together by arrangement with Changemakers.net. It was originally published in the Changemakers Journal.