Sandeep Farias
It’s that time again: a downturn driven by macro global events and sentiment. Much is being said about this ‘winter’ and not a day goes by without folks asking for our views. Sentiments keep shifting. As ‘long-only’ investors in emerging markets (India and Latin America), we have seen multiple highs and lows through the 15 years, and thought it is a good time to talk about a perspective that is timeless, a simple insight based on investing from a ‘ground up’ perspective: Customer centricity and purpose driven strategies can be the handrails of entrepreneurship and capital (irrespective of sector, geography or any such consideration), when markets and the capital ecosystem are ‘good’ or ‘not so good’.
Customer centricity and purpose driven strategies can be the handrails of entrepreneurship and capital (irrespective of sector, geography or any such consideration), when markets and the capital ecosystem are ‘good’ or ‘not so good’.
When we say ‘ground up’, we mean observations and insights from deep within underserved markets, markets that have demonstrated resilience time and time again, through multiple economic turns and macro events like the global financial crisis, the microfinance crisis, multiple liquidity crunches in the debt / financial markets, during Covid-19 lockdowns or when cash was not available in the Indian economy due to demonetization. Based on hundreds of days of immersive field visits, we thought we would write this perspective piece to highlight why we have high conviction in underserved customers (and indeed business models that focus on them, and our entrepreneurs solving for them) weathering macro market conditions, slow downs and even recessions.
Who are These Underserved Customers and What are They Spending On, Irrespective of Market Conditions?
If you were to imagine the classical income pyramid, picture the segment just above the base – the segment that has figured out survival and is aspiring for growth, but lacks access to opportunities and quality essential services. Two aspects make business models that are focused on this underserved segment timeless: first, their resilience and aspirational nature, and second, the customer’s constant need for essential products and services.
While individual customers will always have specific challenges, why do these aspirational low income communities in general tend to handle difficult times reasonably well? Multiple and diverse sources and types of income within a family means that not all sources of income are affected during a crisis, ensuring cash flows for the family.
Multiple and diverse sources and types of income within a family means that not all sources of income are affected during a crisis, ensuring cash flows for the family.
Living based on cash flows ensures that investments and expenditure are calibrated based on the real economy which isn’t necessarily connected with the world of capital, and is often informal and almost always local and hyperlocal (think local healthcare facilities, affordable private schools, hyperlocal trading services for market linkages etc.) Entrepreneurial energy is core to living and not a choice, and so in every household the consumer side and enterprise side of people’s lives are linked. Almost every household earns meaningful income through entrepreneurial activity combined with the clarity that long term investments like education need to be made. Even in difficult times (including in current inflationary times), long term aspirations do not change but important adjustments are made both to find new sources of income and cash flows, and to calibrate consumption decisions. The role of women in the household is even more important during these times particularly when it comes to decisions regarding essential services, and in the generation of new income. All of this ensures a greater resilience, an ability to adapt and cope with difficult times. And that is why we remain confident that this resilience will continue, which makes entrepreneurship and investing for these underserved markets a critical and promising category for the next decade. After all so many MSMEs bounced back post the pandemic to recover losses incurred when markets were in lockdown.
Admiration, however, does not mean romanticizing the lives of low income communities or to ignore potential harsh realities of traditional informal markets. This is why we have focused on ‘essential services’ in our investing, services that form the core of their ‘wallet’ spends.
Admiration, however, does not mean romanticizing the lives of low income communities or to ignore potential harsh realities of traditional informal markets. This is why we have focused on ‘essential services’ in our investing, services that form the core of their ‘wallet’ spends. Limited income means tough decisions on prioritization of expenditure at a household level. There will always be customer demand for essential services. Decisions in relation to essential services are almost certainly led by women in the family, and we are seeing signs of older generations focusing on the education of not just their daughters, but their daughters in law. This means that delivering a quality essential service at a price that is relatively affordable, builds long term brand and social capital with all the members of a household, contributing to long term customer stickiness, revenues and organizational growth. This leads to what we call the twin flywheel effect, where a company’s success is intertwined with the success of its customer. Given how underserved the market still is, even small spends by millions of households in relation to essential services can result in exponential revenues and growth, for brands and organizations building specifically for these communities.
Where Burn is a Calibrated Choice, and Profitability is Part of Day Zero DNA:
We do believe in some sequential actions (core to the Elevar Method) when it comes to building scale across our companies – strong distribution economics / unit economics (the foundation for profitable growth) in the early stages of a company must precede the building out of the organizational platform for scale. And only when the organizational platform is built, one can press the accelerator for non-linear scale, based on the strength of the foundation built. We believe that true impact needs scale, and profitable scale translates to an enduring customer centric company with the ability to attract capital in ‘good’ and ‘not so good’ markets. Often we have seen business models and capital seek to disrupt traditional informal markets or supply chains, but are loss funded by equity investors with deep pockets. Customers move to these new models because of the immediate attraction of the proposition, without an understanding that this is based on unsustainable unit economics, funded by equity. And when markets turn, the equity either dries up or there is a sudden focus on profitability, which inevitably leads to withdrawal of price points that were used to ‘acquire’ market share, leading to adverse implications for the end customer. This is compounded by an inability to return to traditional informal markets or supply chains since historic relationships have already been disrupted. And so for us, building profitable business models premised on quality and affordability is not just prudent business, but impactful and enduring as well.
Talent Driven by a Common Ambition, Beyond Compensation or ESOPs:
Talent is very much like capital, with individuals underwriting companies from a career and personal aspiration standpoint. Great talent is always looking for something more, something fulfilling, impactful and purposeful. When applied to our vantage point, a focus on underserved communities can be a strong hook in attracting world class talent in ‘good’ times. And in ‘not so good’ times, there is so much talent available, looking for opportunities without frothy compensation levels, giving entrepreneurs a chance to separate the wheat from the chaff, and build long term leadership teams.
However Raising Capital is Complicated and Cyclical Irrespective!!
Many wonderful companies were set up, or grew significantly, in the midst of a crisis. Great talent building a business model that is premised on something clear and simple like essential services, on distribution economics, growth and profitability should be par for the course, if one wants to build a customer centric business. In a frothy market, capital is plentiful and there will be sources of capital open to such an approach. In a down market, this is the only way to raise capital.
Ultimately this could well be about entrepreneurial choices. One can have a consistent approach to capital in ‘good’ and ‘not so good’ times, as indicated above. Or one can focus on riding different boats, which could well mean significant valuations in ‘good’ times when investors tend to value growth above all else, and significant course correction in ‘not so good’ times. Our approach has been to focus on the former where one’s strategy and narrative would not frequently change.
One can have a consistent approach to capital in ‘good’ and ‘not so good’ times, as indicated above. Or one can focus on riding different boats, which could well mean significant valuations in ‘good’ times when investors tend to value growth above all else, and significant course correction in ‘not so good’ times. Our approach has been to focus on the former where one’s strategy and narrative would not frequently change.
Irrespective of whether this is a differentiated approach, it is an approach that significantly improves the chance of building enduring and transformational companies, while ignoring vanity metrics like building unicorns.
Or perhaps this is not really about entrepreneurial choices, but about the world of capital; and not just for investing focused on essential services but for all equity investing. What if the world of capital were to build purpose and start to value companies that grow with customer conviction and positive economics higher than those that are loss funded even in ‘good’ times and consistently – in effect, an emphasis on customer driven growth and a de-emphasis on growth at the cost of everything else when liquidity is flush.
What if the world of capital were to build purpose and start to value companies that grow with customer conviction and positive economics higher than those that are loss funded even in ‘good’ times and consistently – in effect, an emphasis on customer driven growth and a de-emphasis on growth at the cost of everything else when liquidity is flush.
Put another way, we need more capital that is purpose driven, where investing conviction and portfolio guidance is based on a customer view and something valuable on the ground, and does not fundamentally shift depending on stock market conditions.
