4 Types of Scaling Barriers for Frontier Firms

April 10, 2019 by in Models
This report isolates potential scaling barriers at four distinct but related levels: the firm itself, the industry value chain of which the firm is a part, public goods relevant to the industry, and governmental laws, policies and actions.
From the Report: Beyond the Pioneer

Most obviously, scaling barriers could lie within the firm itself. It may not have the leadership it needs to drive growth, or the managerial and technical skills needed to operate its business effectively as it grows. It may have developed a business model and structure that worked well when serving just a few hundred people, but cannot effectively serve thousands. And it may simply not have enough financial capital and other internal resources required to fuel its growth.

Value Chain
Looking beyond the firm, we see potential scaling barriers in the industry value chain. If the firm serves poor customers, distribution channels may not exist to take its products to its target areas and communities. For example, many innovative pharmaceutical products do not reach rural areas in developing countries because of the lack of well-developed pharmacy distribution networks. A firm may also find it difficult to source key inputs, such as specialized technical components, in a cheap and reliable way in the areas close to its customers. If the firm is engaging with poor producers, it may lack aggregation mechanisms to help it procure efficiently. For example, an agricultural marketing company in Ghana that sourced produce from thousands of smallholder farmers faced a considerable challenge in managing the logistics, as well as the contractual relationships in a fragmented environment. It was able to succeed once smallholders had been organized into ‘farmer-based organizations’ at the village, district and regional levels, but the scale of the challenge continued to increase as the firm sought to add more smallholders and move into new areas. Access to finance can be a contributing factor to these problems. For suppliers, this could mean that they are unable to invest in additional capacity to serve firms’ needs. For distributors, this could mean they are unable to carry more stock and are therefore unwilling to add novel product lines at the expense of existing ones. Meanwhile, customers’ limited access to credit can make it difficult to finance purchases of durable goods that represent a significant proportion of a household’s monthly income. For example, mainstream banks in South Asia are often reluctant to lend to poor households wishing to buy solar home electricity systems even though there is evidence that such systems tend to lead to substantial increases in household incomes. As a result, providers have had to facilitate bank loans or even provide credit for these customers in order to drive purchases.

Public Goods
Customers may not even be ready to buy these products, especially if the products are unfamiliar. Poor households have limited means and are economically vulnerable, which makes them highly risk averse; few will be in a rush to adopt innovative products, even if their use could bring significant benefits. Lack of awareness of new products, and appreciation of their value, could therefore be a key scaling barrier. This is particularly severe for push products. However, such awareness and appreciation is typically a public good, because it benefits not only the pioneer but also all
the other firms that enter the same industry. Another public good that is often lacking in these environments is hard infrastructure. Poor road networks, erratic power supplies, and patchy and unreliable telecommunications networks are common, especially in rural regions. While firms can sometimes overcome—or work around—these issues on a limited scale by choosing initial operating areas that have adequate infrastructure, the lack of wider availability of infrastructure makes it difficult for them to scale further. Yet another potential public good deficit in this context relates to information and knowhow needed by the industry. There is typically a weak understanding of poor customers—where they live, what they desire, how they make buying decisions, how they use products, and so on—while wealthy customers are often well understood. Partly as a result of this, general knowledge of what works in creating and scaling a business to serve poor customers is also likely to be limited. Not only could this impede the growth of existing firms in the industry, it also makes it difficult to attract new entrants. The lack of effective quality standards could also be a scaling barrier, because many inclusive business products are higher-quality alternatives to goods or services that the poor are already buying. For instance, poor households in many countries consult private medical practitioners and send their children to cheap private schools because of the dismal level of public provision. The problem is that consumers are unable to reliably assess the quality of the services they buy, particularly in areas such as healthcare and education where they often rely on poor proxies for quality (such as whether their child wears a uniform to school, or gets prescribed medicines at the clinic). As a result, high-quality providers may not enjoy the advantage they deserve in the marketplace. Conversely, high-quality product markets can also be spoilt by the entry of low-quality competitors. For example, we have observed how the early success of high-quality community water plants in urban slums then attracts informal players with much less stringent quality standards; if left unchecked, this has the potential to devalue the entire community water plant model in the eyes of local consumers.

There is a further class of scaling barriers that relates to government actors, such as legislators and governmental (or quasi-governmental) agencies. The most obvious barrier comes from laws, regulations and procedures that inhibit the firm from operating its model easily, often because they are designed to regulate mainstream models rather than innovative ones. For example, Indian law describes minimum standards for schools that include a ratio of one trained teacher to every 30 students, and the provision of playgrounds and libraries in every school. However, the limited supply of qualified teachers means that India is short by an estimated 1.2 million teachers, and there is also lack of suitable school premises. Innovative low-cost school models have delivered strong educational outcomes for poor children by working around these challenges: they use paraskilled classroom instructors rather than qualified teachers, and operate in temporary classrooms with few amenities. However, while such models may be able to operate locally with the approval of municipal or district government officials, their lack of compliance with national legislation represents a key barrier to widespread scaling across the country. Government taxes and subsidies may represent another scaling barrier. For example, solar lighting products provide poor rural households with a safer and cleaner source of light than kerosene lamps. However, solar products in a number of African countries are subject to a range of taxes and duties, reducing their affordability and attractiveness in relation to kerosene, which is exempt from these levies and in some cases even benefits from government subsidies. This uneven playing field makes it more difficult for solar lighting providers to scale. Sometimes, official institutions may act outside of these established frameworks in ways that are adverse to pioneer models, particularly in countries with less developed governance systems. These may include actions to restrain the activities of the industry, or actions to support other, often incumbent, industries that pioneer firms are threatening to displace as they grow. Observant readers will have realized that a conducive framework of government is also a public good for our industry. However, we believe that the nature, structure and dynamics of government institutions are so distinct from the market sphere inhabited by firms and other industry participants that it is worth highlighting them separately.”

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