72695 From Gap to Opportunity: Business Models for Scaling Up Energy Access In partnership with Austria 1 EXECUTIVE SUMMARY ABOVE: AFRICAN CONSUMERS WITH A PORTABLE SOLAR LANTERN (CREDIT: IFC) CONTENTS 2 Contents FOREWORD .............................................................................................................................................................. 7 ACKNOWLEDGMENTS ...................................................................................................................................... 8 ABBREVIATIONS ..................................................................................................................................................... 9 EXECUTIVE SUMMARY .................................................................................................................................... 11 CHAPTER 1: INTRODUCTION .................................................................................................................... 21 Reframing Energy Access as a Market ......................................................................................................................... 23 Defining Ways to further Catalyze Commercial Success Stories ................................................................................... 25 CHAPTER 2: SIZING THE ENERGY ACCESS MARKET .................................................................. 27 CHAPTER 3: HOW COMPANIES ARE SERVING THE MARKET .............................................. 37 Household-level Devices and Systems ..........................................................................................................................40 Devices: Business Models – How Companies are Serving the Market ...........................................................................44 Devices: Key Business Model Success Factors .............................................................................................................. 60 Devices: Key Success Factors in the Ecosystem Environment ........................................................................................66 Community-level Electrification through Mini-Utilities ................................................................................................. 75 Mini-utilities: Business Models – How Companies are Serving the Market .................................................................. 79 Mini-utilities: Key Success Factors in the Business Model .............................................................................................88 Mini-utilities: Key Success Factors in the Ecosystem Environment ................................................................................ 93 Grid-based electrification: Centralized Utility Approaches ......................................................................................... 101 Grid Extension: Business Models – How Companies are Serving the Market ............................................................. 101 Grid Extension: Key Success Factors in the Business Model ........................................................................................111 Grid Extension: Key Success Factors in the Ecosystem Environment ........................................................................... 114 CHAPTER 4: WHAT CAN BE DONE TO HELP SCALE-UP ENERGY ACCESS SUCCESS STORIES? ............................................................................................................................................117 Refining Business Models: Challenges for Operating Companies ............................................................................... 120 Rethinking Policy: Roles for Governments and their Development Partners ............................................................... 126 Refocusing Financing: Opportunities for Impact and Commercial Investors ............................................................... 133 APPENDIXES A: Market-sizing Methodology ................................................................................................................................. 145 B: Socioeconomic Impact of Serving the Energy-Poor ............................................................................................... 159 C: How Mini-Utilities Grow into Big Utilities .............................................................................................................. 160 D: Grid Extension – Recent Relaxation of Exclusive Arrangements ............................................................................. 161 E: Photo Credits ......................................................................................................................................................... 162 NOTES ....................................................................................................................................................................... 163 REFERENCES ........................................................................................................................................................ 168 3 CONTENTS Contents BOXES 3.1 Tizazu makes improved cookstoves in Ethiopia ...................................................................................................... 47 3.2 Unilever Tea Kenya Limited has tapped CSR funding to successfully purchase and disseminate solar PV devices .... 52 3.3 Fenix’s ReadySet, deployed in partnership with MTN ............................................................................................ 53 3.4 Nuru Energy and its Rechargeable Solar Lamps ..................................................................................................... 55 3.5 Greenlight Planet: Building its own distribution network ....................................................................................... 62 3.6 Community-based systems have a role to play ...................................................................................................... 77 3.7 Vihearsur Electrify Enterprise, Cambodia ............................................................................................................... 82 3.8 Bonny Utility Company, Nigeria ............................................................................................................................. 83 3.9 Government policy drives mini-utility outcomes: Encouraging private developers in Tanzania ................................90 3.10 Government policy drives mini-utility outcomes: Community power in Nepal ...................................................... 97 3.11 Case studies on reduction of nontechnical losses – JPSCo and RAMI ................................................................. 106 4.1 Commonwealth Development Corporation as a mini-utility developer and platform company ............................ 123 4.2 Understanding financing constraints ................................................................................................................... 137 4.3 Risk-sharing facilities can encourage the provision of debt .................................................................................. 139 4.4 Examples of risk-sharing facilities ........................................................................................................................ 140 4.5 The Shell Foundation is taking a venture capital approach .................................................................................. 143 FIGURES 1.1 Share of people without access to modern energy in 2007 ................................................................................... 22 1.2 Analytical framework used to study companies operating in the energy access market ........................................ 24 1.3 Scope and methodology of the report ................................................................................................................. 25 2.1 Distribution of household expenditures on traditional energy ............................................................................... 28 2.2 Energy access solutions discussed in this report .................................................................................................... 29 2.3 Theoretically addressable market for “lighting plus” and improved cooking in 2010 ............................................. 30 2.4 Commercial price of modern energy alternatives .................................................................................................. 31 2.5 Theoretically addressable market by technology category ..................................................................................... 32 2.6 Sensitivity of the addressable market to up-front cost ........................................................................................... 33 2.7 Sensitivity of the addressable market to willingness to pay .................................................................................... 35 2.8 Penetration rates of energy and mobile phone services in developing markets ..................................................... 36 CONTENTS 4 Contents 3.1 Overview of selected energy access ventures – subsector, model, and customer base ........................................... 39 3.2 Solar and rechargeable technologies for lighting and providing electricity for the home ....................................... 41 3.3 Characteristics of selected companies covered in this section ............................................................................... 43 3.4 Devices – how companies are serving the market ..................................................................................................44 3.5 Sample cost breakdown of a device made by an Indian solar lantern company ..................................................... 50 3.6 Sample cost breakdown of SHS installed by an Indian company ........................................................................... 56 3.7 Key success factors in the devices business model ................................................................................................. 60 3.8 What is your preferred type of light, excluding electric light bulbs powered from the grid?, Ethiopia .................... 63 3.9 Sample cost breakdown of a device made by an Indian cookstoves company .......................................................64 3.10 Key success factors in the devices ecosystem environment ..................................................................................66 3.11 Financing needs and obstacles early in the company life cycle ............................................................................. 70 3.12 Overview of mini-grid technologies ..................................................................................................................... 75 3.13 Electricity generation costs by mini-grid technology ............................................................................................ 78 3.14 Mini-utilities – how companies are serving the market ........................................................................................ 79 3.15 Generalized mini-utility operating model .............................................................................................................80 3.16 Shared Solar PV metering concept ...................................................................................................................... 87 3.17 Key success factors in the mini-utility business model ..........................................................................................88 3.18 Indicative cost structure of mini-utility, example from India ................................................................................. 93 3.19 Key success factors in the mini-utility ecosystem conditions ................................................................................94 3.20 Location of electrification entities profiled in this section .................................................................................. 102 3.21 Grid extension – how companies are serving the market .................................................................................. 102 3.22 Key success factors in the grid extension business model ...................................................................................111 3.23 Key success factors in the grid extension ecosystem environment ......................................................................114 4.1 Regional electrification rates and regional electricity access show the scale of the commercial opportunity in providing new energy access solutions ...................................................................................................................... 118 4.2 Summary of key success factors and recommendations ...................................................................................... 119 4.3 Growth in base stations in developing regions (2007–12) ................................................................................... 122 4.4 Financing is needed in three areas: To support companies in their early stages (start-up and growth capital), to support operations (working capital or trade finance), and to strengthen revenue streams .................................. 135 5 CONTENTS Contents A.1 Addressable market for modern energy products and services ........................................................................... 147 A.2 Addressable market for improved cooking – charcoal ........................................................................................ 154 A.3 Addressable market for improved cooking – wood ............................................................................................ 154 TABLES 4.1 Where energy access companies look for financing, off-grid lighting example .................................................... 141 A.1 Alternative modern lighting and electricity technologies...................................................................................... 148 A.2 Sensitivity analysis of up-front payments on the addressable market .................................................................. 150 A.3 Sensitivity analysis of up-front payments “across the board” on the addressable market ................................... 151 A.4 Sensitivity analysis of price on the addressable market ....................................................................................... 151 A.5 Sensitivity analysis of price “across the board” on the addressable market ......................................................... 152 A.6 Sensitivity analysis of willingness to pay for electricity on the addressable market .............................................. 152 A.7 Sensitivity analysis of household incomes on the addressable market in 2030 .................................................... 153 A.8 Improved cooking devices .................................................................................................................................. 154 A.9 Sensitivity analysis of up-front payment on addressable market for improved cooking ....................................... 156 A.10 Sensitivity analysis of up-front payment on addressable market for improved cooking – across the board ........ 156 A.11 Sensitivity analysis of price on addressable market for improved cooking .......................................................... 158 A.12 Sensitivity analysis of price on addressable market for improved cooking – across the board ............................ 158 A.13 Sensitivity of willingness to pay and income levels on the addressable market .................................................. 158 A.14 Sensitivity analysis of household incomes on the addressable market in 2030 .................................................. 158 B.1 Health and environmental benefits of modern lighting solutions ........................................................................ 159 B.2 Health and environmental benefits of improved cooking solutions ..................................................................... 159 CONTENTS 8 ABOVE: AFRICAN CONSUMER WITH A TORCH (CREDIT: IFC) 7 FOREWORD Foreword The critical challenge of extending access to electricity and clean cooking fuels to the poor is deservedly taking center stage in this International Year of Sustainable Energy for All, as proclaimed by the United Nations Secretary General. Governments, members of the development community, and representatives from the private sector are coming together around a goal of universal access to modern energy by 2030. It is ambitious, but there is room to make significant progress that can create opportunity and improve lives. The challenge Today, one-quarter of the world’s population lives without electricity, and almost one-half lacks clean cooking fuels, depriving people of vital development opportunities and undermining progress on many of the Millennium Development Goals. Despite intensified efforts at the national and international levels, there remains a significant shortfall in the volume of investment needed to achieve universal energy access. While it will cost $48 billion per year to reach this goal, according to the International Energy Agency, only about $14 billion is available annually. Given the size of this difference, it is clear that the public sector cannot meet the need alone. Leveraging the private sector—both in terms of capital and innovation—will be critical to closing the energy access financing gap. There is another way to look at the challenge: energy access as an opportunity for business. That is the focus of this report. The opportunity We examine the size of the market for modern energy services. We discuss how profit-making firms— be they local small and medium enterprises or global multinationals—are already supplying valuable products and services to the poor. We analyze the operating fundamentals of these companies and identify the conditions that have made them successful. We also suggest ways in which the market can be further tapped by enterprises and catalyzed by policymakers and investors—both social and commercial. Our research estimates that people worldwide spend about $37 billion annually on kerosene used for lighting and biomass used in open fires or polluting traditional stoves for cooking. There are an emerging number of manufacturers, distributors, and service providers offering enhanced technological options—ranging from isolated mini-grids and solar home systems for electricity to solar lanterns for lighting and improved stoves for cooking. These solutions offer greater value and quality, and are healthier and better for the environment. Such firms are successfully innovating and developing new approaches to serving the market, in many cases overcoming challenges along the value chain that have in the past made it difficult to serve people living on the lowest incomes. More than 100 businesses from around the world have been reviewed and assessed for this report, demonstrating that there is demand for products and services offered commercially in energy access. These examples show that companies can play an important role in serving a segment of the market. Moreover, they demonstrate how collaboration among firms, governments, impact investors, and the development community can open up markets for commercial investment, helping to close the energy access financing gap and delivering services to the poor more efficiently and cost-effectively than perhaps previously thought possible. Nena Stoiljkovic Vice President, IFC Business Advisory Services ACKNOWLEDGMENTS 8 Acknowledgments This report, which explores the global market opportunity for expanding access to modern energy services at the household level, was funded by the Government of Austria and prepared by IFC’s Sustainable Business Advisory Department. The lead author was Pepukaye Bardouille, who also managed the project with guidance and thought-partnership from Patrick Avato, and input from Jeremy Levin, Alexios Pantelias, and Hendrik Engelmann-Pilger of IFC’s Global Clean Energy Advisory Team. We would like to acknowledge the support of Castalia Advisors and Hystra Consulting in undertaking background research, Terrestrial at the finalization and production stages of the report, and Diane Stamm for final editing. In addition, we are grateful for the input of external advisors, colleagues, and peer reviewers who have been involved at various stages of the project. They include Roberto Bocca, World Economic Forum; Anil Cabraal, Consultant; Raffaella Centurelli, International Energy Agency; Simon Desjardins, Shell Foundation; Rodd Eddy, Consultant; Rajan Kundra, Acumen Fund; Emmanuel Léger, Total; Kilian Reiche, iiDevelopment; Antonio Volpin, McKinsey & Company; and Adam Wolfensohn, Wolfenson & Company; within IFC: Nana Asamoah-Manu, Leo Blythe, Naomi Bruck, Vyjayanti Desai, Ricardo Gonzalez, Sabine Hertveldt, John Kellenberg, Geoffrey Lang, Toshiya Masuoka, Hemant Mandal, Euan Marshall, Itotia Njagi, Reinhard Reichel, Dirk Sommer, Russell Sturm, and Dana Younger; and at the World Bank: Adriana de Aguinaga de Vellutini, Sameer Akbar, Katherine Deaton-Steel, Dan Kammen, Yogita Mumssen, Venkata Ramana Putti, Dana Rysankova, and Bernie Tenenbaum. We would also like to thank the many companies and organizations interviewed during the course of the research for their invaluable data and insight, including Andoya, Barefoot Power, d.light design, Dasra, Duron, E+Co, Electricité de France, Envirofit, Fenix International, First Energy, Greenlight Planet, Grassroots Business Fund, GSM Association, Husk Power Systems, Infrastructure Development Company Limited, Intellecap, KwaZulu Energy Services, MoserBaer, Noble Energy Solar Technologies, Nigeria LNG, Nuru, Power Source, SELCO, Shared Solar, Simpa, Soluz, TataBPSolar, Tecnosol, Tizazu, Toyola, and Vihearsur Electrify Enterprise. The collaboration and assistance of all the people, organizations, and companies mentioned here has enabled us to estimate the proportion of people currently relying on traditional energy to meet their lighting and cooking needs that could be served commercially by modern alternatives; to explore factors that have contributed to the success of some of the many businesses already serving the energy access market; and to offer recommendations to operating companies, social and commercial investors, and policymakers on how these promising but still nascent ventures can be further scaled. We hope these findings will inform the debate on options for achieving universal energy access. 9 ABBREVIATIONS Abbreviations AEC Ahmedabad Electricity Company Limited AGECC Advisory Group on Energy and Climate Change (United Nations) ARPU average revenue per user ATA Agricultural Transformation Agency (Ethiopia) BIDS Bangladesh Institute of Development Studies BOP base of the pyramid BUC Bonny Utility Company CARD MRI a leading microfinance institution CDC Commonwealth Development Corporation (United Kingdom) CDM Clean Development Mechanism CEMAR the private utility serving the Brazilian State of Maranhão CEO chief executive officer CEPALCO Cagayan Electric Power and Light Company (the Philippines) CERs certified emission reductions CHUEE China’s Utility-based Energy Efficiency Finance CSR corporate social responsibility DAC Development Assistance Committee (OECD) DESI Power Decentralized Energy Systems, India Power DfID Department for International Development (United Kingdom) DOMLEC Dominica Electricity Services Limited EBITDA earnings before interest, taxes, depreciation, and amortization EU European Union EU ETS European Union Emissions Trading System EWURA Energy and Water Utility Regulation Authority (Tanzania) FiTs feed-in tariffs FMO Netherlands international development bank GDP gross domestic product GIZ Deutsche Gesellschaft für Internationale Zusammenarbeit, German Agency for International Cooperation GRENLEC Grenada Electricity Services GSMA the international association of mobile phone operators HPS Husk Power Systems (India) ICP International Comparison Program IDCOL Infrastructure Development Company Limited (Bangladesh) IEA International Energy Agency IFC International Finance Corporation IREDA India Renewable Energy Development Agency JPSCo Jamaica Public Service Company Kf W Kreditanstalt für Wiederaufbau, Reconstruction Credit Institute (Germany’s development bank) kW kilowatt kWh kilowatt hour LED light-emitting diode ABBREVIATIONS 10 Abbreviations LUCELEC St. Lucia Electricity Services MONLEC Montserrat Electricity Services MTN an African mobile operator MW megawatt NDPL North Delhi Power Limited NEST Noble Energy Solar Technologies NGO nongovernmental organizations NLNG Nigeria Liquefied Natural Gas ODA overseas development assistance OECD Organisation for Economic Co-operation and Development OPIC Overseas Private Investment Corporation (United States) PEMANDU Performance Management and Delivery Unit (Malaysia) PERG Morocco’s Global Rural Electrification Program PLN Indonesia’s state-owned power company PPP public-private partnership PPP purchasing power parity PV photovoltaic R&D research and development RAMI Residential Advanced Meter Infrastructure REPRO Rwanda Renewable Energy Promotions RESCO Rural Energy Services Company (France) RSFs risk-sharing facilities Sacco savings and credit organization (Kenya) SHS solar home system SMEs small and medium enterprises SMS short message service SNV an international nonprofit organization, started in the Netherlands SPP small power producer TataBPSolar a joint venture between Tata Power Companies and BP Solar (India) TSch Tanzanian shillings UN United Nations UNDP United Nations Development Programme UNELCO a subsidiary of France’s GDF-Suez USAID United States Agency for International Development UTKL Unilever Tea Kenya Limited VAT value-added tax VEE Vihearsur Electrify Enterprise VINLEC St. Vincent Electricity Services Limited VSPPs very small power producers WHO World Health Organization Wp watt peak WRI World Resources Institute 11 EXECUTIVE SUMMARY Executive Summary ABOVE: ACCESS TO MODERN ENERGY SOLUTIONS ALLOWS LOW-INCOME CONSUMERS LIKE THIS ARTISAN TO BE MORE PRODUCTIVE (CREDIT: IFC) EXECUTIVE SUMMARY 12 While there is broad recognition that lack of access to modern for cooking each month. A number of these players—ranging energy has major implications for development, the energy from international social enterprises to local small and medium access gap is increasingly being seen as a market. Given the enterprises (SMEs), domestic conglomerates, and multinational vital role it plays in socioeconomic development, providing corporations—have already established significant customer improved access to energy has typically been the role of state- bases, or hold promise for scaling up given the right conditions. owned power utilities, rural energy agencies, international While this is still a nascent sector, many businesses are rapidly development and nongovernmental organizations, and other moving beyond being cottage industries and are successfully public entities. However, with growing recognition of the serving tens of thousands to hundreds of thousands of customers. potential for “base of the pyramid” (BOP) customers to become Some companies are seeing profit margins of 10 percent to 30 fast-growing markets for goods and services on the one hand, percent, often with fairly small subsidies on capital costs (but not and the emergence of novel models for serving them on the on operational costs) or no subsidies at all. other, the energy access gap is increasingly being recognized as a commercial opportunity, too. The nature of that market, and the segments within it, is the focus of this report. “$37 billion spent each year on low- quality energy solutions represents Sizing the energy access market a largely untapped market opportunity opportunity for the private sector.” Each year, the poor spend $37 billion on poor-quality energy solutions to meet their lighting and cooking needs. This represents a substantial and largely untapped market for the We explore three ways in which companies are providing private sector to deliver better alternatives. It is estimated that improved energy access: over one-fifth of humankind lacks modern energy services and • Household-level devices and systems—including solar that the cost of providing “universal access” to the electricity grid lanterns, solar home systems, and improved biomass cook- and decentralized electrification systems would be in the tens of stoves—offer a basic first step up the energy ladder and are billions of dollars annually (if the institutional and structural often the most cost-effective option for the dispersed rural issues in the utility sector could be addressed to enable such a poor, and for those who live in urban slums. setup). • Community-level mini-utilities—often powered by hydro This report posits, however, that an estimated 90 percent of or diesel generators but increasingly using biomass, solar, (poor) people already spend so much on kerosene lamps, candles, and wind energy—provide households and small manu- and disposable batteries to meet their lighting needs that they facturing and commercial firms with electricity, often for could afford to purchase better options, such as solar lamps. much less than what they currently spend. Even more people could afford efficient cookstoves because of the fuel cost savings they offer. Those who are skeptical about the • Grid-based electrification—is proving to be a viable option prospect should consider the spectacular takeoff of mobile phone for new customers in many previously unserved urban ar- devices. In Africa, the number of subscribers using devices that eas. “Informal consumers” are also being regularized into cost as little as $20—which is at the low end of the cost of many bill-paying clients. modern energy access devices—has been increasing at a rate of 30 percent annually for the past 10 years. On a continent of 1 This study of over 100 enterprises shows that with the right billion people, of which some 73 percent live on less than $2 a business models and enabling conditions, the private sector day, there are currently 620 million cell phone subscriptions, and can play an important role in helping to close the energy access gap. Each of these market segments exhibits particular the user base is expected to hit 735 million in 2012. characteristics in terms of target consumers, technologies, delivery approaches, and economics. They also require specific Exploring how companies are business ecosystem conditions—that is, legal provisions and regulatory frameworks—for success. But this analysis of serving the market commercial ventures from around the globe shows that when The good news is that pioneering companies are already innovative companies, frontier financiers, and enlightened making money from selling superior energy access options to policymakers come together, business can successfully deliver households spending as little as $2 on lighting and $1.50 on fuels valuable energy services to the poor. 13 EXECUTIVE SUMMARY Household-level systems and devices The household-level systems and devices industry has attracted the greatest private sector innovation. With barriers to entry fairly low, dozens of companies are active across Africa, Asia, and Latin America. Local and international start-ups are growing quickly and some multinational corporations are exploring entry routes into the market. Solar lanterns priced between $20 and $50 are often the most affordable way for poor customers to purchase improved lighting services. Rooftop solar home systems (SHS) that cost $300 to $500 can provide sufficient power for a household or small retail business and have a fairly long history among both entrepreneurs and development institutions. Companies are also selling efficient biomass cookstoves for as little as $5 to $25. These stoves offer improved fuel consumption of 30 to 50 percent, meaning dramatically reduced operating expenditures, reduced indoor air-pollution levels, and a reduced burden on the environment. The business models adopted by lighting and cooking device companies vary. Many of the smaller international solar lantern players, in particular, focus on design and marketing, and outsource their manufacturing. Cookstove companies are often indigenous SMEs that employ artisans to make no-frills devices tailored to local tastes and conditions. But a few international players are entering the stoves space, offering more sophisticated and generally more expensive products. They prioritize design appeal and product quality, and often work with public sector partners to help market stoves, and to spread the word about their benefits. SHS players are typically active across much of the value chain. Given that system sizes and add-ons are best designed to address local conditions and user requirements, many of them develop and assemble components, and provide comprehensive installation services and after-sales support. “When innovative companies, frontier financiers, and enlightened policymakers come together, business can play an important role in helping to close the energy access gap.” Affordability is an obvious success factor for devices, and firms try to build this into as many aspects of the business as possible. Homegrown cookstove SMEs often leverage open-source designs (typically shared by nongovernmental organizations [NGOs] and development partners) while concentrating internal efforts on low-cost manufacturing using locally available materials, including cheap scrap metal. In the lighting market, economies of scale have led to solar lantern and panel prices dropping sharply, thus increasing their relevance to low-income consumers. But research and development (R&D), too, has played a role in the emergence of very low- cost products. “Solar kits” have surfaced as an alternative to traditional SHS—which can be too expensive for commercialization at scale in many markets without either direct subsidies or the availability of large amounts of concessional finance that the SHS provider can on-lend to customers, thus helping to spread payments over time. Solar kits are portable systems that allow households to run multiple lights and charge small devices. Priced at $100 to $200, these kits are more affordable than SHS and require no installation or regular maintenance. Smartly designed solar kits are also proving to be aspirational, helping to increase market penetration. On the payment side, rental and pay-as-you-go billing approaches are helping to reduce the up-front costs for consumers. EXECUTIVE SUMMARY 14 For higher-priced items such as SHS, companies must But device manufacturers also have to work hard to create typically offer consumer credit to make them affordable; this consumer confidence in new technologies. As with any new is often done in partnership with microfinance institutions equipment supplier, leading-edge device players are faced with that have access to concessional financing for on-lending to cautious customers reluctant to risk their money on unfamiliar consumers. Despite the historical emphasis on the importance technology. Overcoming this can become a major marketing of microfinance for helping BOP customers access products, cost—exceeding conventional brand-building expenditure. many companies are seeing that this may not be needed for Manufacturers have used a variety of highly effective low- smaller-ticket items, such as solar lanterns and cookstoves, cost tactics to overcome this barrier, such as word-of-mouth especially since technology costs have fallen. A handful of firms marketing, publicly funded radio campaigns, and roadshows. are tapping carbon finance, notably in the cookstove space. But, for many, awareness raising and market development is an However, they are finding that significant support is needed to important financial sink; companies report that this typically get through the process of applying for credits. adds 6 percent to 10 percent to device costs. Fundamentally strong distribution networks and supply chain Device companies thrive in an ecosystem where the playing financing are “make-or-break” for devices businesses. In order field is level. That is, when there is sufficient technology to effectively penetrate BOP markets that are often in hard-to- awareness, product standards exist, and tax and duty regimes reach rural areas, some companies sell devices through partners do not discriminate against them. When these factors are that have largely overcome last-mile distribution challenges combined with training and support of entrepreneurs, finance to sell or distribute their own offerings, notably NGOs and for growth, and in some instances carbon credits to help bring microfinance institutions. The results have been mixed since down the cost (of cookstoves in particular), successful device incentives are not always aligned. Most companies stick to firms emerge and grow rapidly. traditional retail channels in urban areas while establishing their own sales force in rural communities; typically, these rural salespeople go door-to-door in their own and in neighboring Community-level mini-utilities villages, demonstrating how products work and building trust Small, decentralized mini-grid businesses—we call them that the seller can be traced if the product needs repair. Still “mini-utilities”—are found in poor areas across the developing others incentivize dealers to stock their items by offering a world and can offer sufficient power for both household and disproportionately high percentage of profits, leaving them to productive use. These entities vary enormously in scale but are manage marketing, working capital, and other downstream generally from 30 kilowatts (kW) to 500 kW and use a range issues. However, financing the length of the distribution of technologies, from simple diesel generators to hydropower, chain, from the import of containers to wholesalers, through biomass, photovoltaic, or hybrid systems. Many mini-utilities to distributors and then on to often many levels of retailers, deliver electricity at $0.20 to $0.50 per kilowatt hour (kWh), can be costly. allowing most families to meet basic energy needs for less Financing distribution is typically a natural comparative than $10 per month. This is a significant expenditure, but the advantage of larger companies. Multinational corporations, economics are attractive in many places because households in particular, are leveraging strong balance sheets, taking already spend as much on kerosene and charging services for advantage of their brand names to get into the game and then small appliances. Importantly, mini-utilities often provide quickly developing strong supply chains—from warehousing sufficient power for activities such as water pumping, milling, infrastructure to distributor credit facilities—to capture grinding, and other forms of processing, thus supporting local economic development. market share. There are, however, early signs of smaller players exploring innovative ways to deal with working capital by Profitable mini-utilities have an adequate demand for power; a selling to large, nonconventional dealers—in some cases, local reliable, cheap fuel source; and good bill collection approaches. conglomerates or multinational corporations—that serve as For mini-grids to size systems optimally and operate efficiently, aggregators and are well placed to provide the necessary trade they require sufficient baseload. This is often achieved by finance to retailers downstream. In one instance, a major oil serving a mix of household and SME customers, with the latter and gas company interested in the access market is establishing providing a more predictable demand for electricity over time, distribution channels (that tap its petroleum filling stations in and the ability to pay for it. While diesel is often a preferred fuel selected countries) for solar lanterns, with the jury still out as to given its availability, many companies use renewable energy to whether it will develop a proprietary lighting product. keep costs down and more predictably stable. Where available, 15 EXECUTIVE SUMMARY biomass feedstock is a good option, but it also creates several challenges in controlling supply that mini-utilities must overcome. On the revenue management side, some companies are installing low-cost meters and switches that allow for easy disconnection in the case of nonpayment. Others charge fi xed monthly fees for a limited service, such as sufficient power for a couple of lights and charging of appliances, generally collected a month in advance. Beyond formal billing systems, developing close ties to the community is important, and successful mini-utilities work hard to be an integral part of the community. Interestingly, formal business skills are not an initial requirement for mini-utility success, but they do become critical for scaling up beyond a single site or a handful of sites. This is especially true for mini-utilities using renewable technologies, which are more sophisticated or have higher maintenance requirements than diesel generators. Mini-utilities thrive in an ecosystem where they have the right legal and regulatory framework and good financing options. Simply put, mini-utilities must be allowed to operate and to do so under a regime where tariffs allow an attractive return on investment. Perhaps surprisingly, this is not always the case—in some countries mini-utilities are not permitted and in others they are subject to onerous regulations or non-cost-reflective tariffs. Where the right environment exists, profitable businesses operating one or a handful of plants can be found. But there are circumstances where some degree of subsidy is provided to make mini-utilities profitable. This is generally the case where governments are seeking to encourage private developers to enter the market but where tariffs alone are not commercially sustaining, where low population density increases the cost of building distribution networks, or where consumers are simply too poor to support the required revenues. In most instances, public financing comes in the form of a capital subsidy, ranging from 30 percent in India to up to 80 percent in Mali. More broadly, these companies need sizable investment to scale, yet most struggle to raise sufficient debt and equity for this. We believe that the ongoing success of mini-utilities will be linked to their ability to access these funds. Grid-based electrification For almost all governments, universal grid-based electrification is the endgame, yet levels remain very low in many parts of the world. Grid-based electrification supports economic and social development imperatives by providing the quantity and quality of services required for large energy-intensive industrial activities. It also allows for economies of scale in generation and efficiency in establishing peaking and back-up plants, reducing overall system costs. But only 30 percent of the population in Sub-Saharan Africa and 60 percent in Southeast Asia are connected to a network. Even when access to the grid is available, customers in many developing countries are plagued by unreliable power. Where system inefficiencies and theft create significant losses, utilities are unable to cover their costs. The result is that companies struggle with solvency and are unable to provide high-quality service to existing customers, let alone deliver new connections. Hence, despite having “access,” it is not unusual for households and businesses to rely on expensive power from back-up generators to make up for poor utility service. There is a market opportunity to connect previously unserved households profitably. Beyond the prospect of providing improved service to existing grid-connected customers, some companies— most notably in urban and peri-urban areas in Brazil, India, and Colombia—have through choice or circumstance become smarter at serving the poor. In some cases, they have achieved this by turning households and businesses that were purchasing excessively expensive and often intermittent services from informal suppliers in their communities into utility customers. In other EXECUTIVE SUMMARY 16 instances, they have taken money off the table by regularizing seizing the opportunity to profitably supply appropriate, consumers who may not have formally been paying for the affordable goods and services to the poor. But despite services they used. All have typically succeeded by installing the progress made in technology innovation and delivery prepayment meters, providing payment flexibility, offering approaches over the past decade or so, there remains much consumer finance to encourage the use of legal connections to be done before this becomes a more “mainstream” area on and, more broadly, operating their businesses efficiently. par with mobile telephony, for example. In particular, very fundamental scale-up and replication challenges will have to Grid extension can benefit from policies that explicitly support be addressed if the sector is to achieve its potential. There are a private participation. This means removing limits on service number of areas on which operating companies, policymakers, areas where it makes sense, relaxing restrictions on serving and impact investors (social venture capitalists and donors) can informal settlements, allowing flexibility in tariff regulation, focus to further catalyze commercial activities in energy access. and financing the connection of the end customer. But high costs and limited consumption by low-income Refining business models: challenges consumers mean that purely commercial models for grid- electrification are still rare; public funding has played an for operating companies to address important role in the success of most truly large-scale extension Companies should continue to design for radical affordability programs. The capital investment required to generate power in every area of operations. Businesses serving the BOP and extend lines means that grid extension is costly. Meanwhile invariably require volume to make up for typically low margins. many unconnected customers have low incomes and therefore Affordability is critical for this and can continue to be achieved have limited consumption, resulting in slim returns. In through innovation on product and service design, business addition, a large portion of unelectrified urban households live model innovation, and provision of consumer finance, either in slums, with the implication that they are unlikely to have directly or indirectly. legal tenure and may thus not qualify for—or are prohibited Perhaps the most important factor for all device companies is by municipalities from formally accessing—electricity services. to secure robust distribution channels. Partnering strategically Where providing widespread grid-based access for the energy with companies that have already established strong distribution poor has been successful, as in China, South Africa, and channels is one way of getting products to market more quickly. Vietnam, this has largely been a result of explicit policies For example, tie-ups with mobile telephony network operators mandating it and has been backed by significant financial could be a good start, because the products are complementary commitments from the public purse. Commonly, governments (charged cell phones benefit the mobile operator’s average revenue choose to award concession contracts for new or privately per customer) and they require similar supply chains for getting owned distribution companies to serve currently unserved goods to customers and financing them along the way. Equally, if areas. This can also be combined with smart subsidies to a company has been able to develop strong networks of its own, it extend access even further than would be viable on a purely could leverage this asset to cross-sell other products. These might commercial basis. Private companies often bring access to be other energy devices (such as cookstove manufacturers that capital and new management approaches, which allow them to also sell solar lanterns) or other products that would be desirable increase connections more quickly than public utilities, while to end users such as radios, irrigation pumps, and water purifiers. improving the bottom line. Device players, that is, companies in the device market, should also concentrate on ensuring sufficient working capital to support retailers in stocking products; in many cases, this will require Acting on the findings: what can be partnering with firms able to provide such financing. done to scale-up energy access success For mini-utilities, the operating basics are focused on innovative stories? approaches to developing multisite systems. Once they have mastered the reliable supply of low-cost fuel and secured sufficient There is a real market opportunity for closing the energy gap; demand, most companies struggle to find a replicable business however, scale-up and replication challenges will need to be model that allows them to leverage the economies of scale that addressed. This report asserts that energy access is not just a are critical for growth. While there are no easy remedies, one development gap, but also a real market opportunity for the option to explore could be the “anchor client” model. Here, private sector. Around the world, entrepreneurs are already a mini-utility would partner with mobile network operators 17 EXECUTIVE SUMMARY (to manage the power needs of off-grid base stations) or other the device manufacturers) begin life as social enterprises, the businesses, such as commercial farms or extractive industries, social benefits of their endeavors are usually well communicated. and in parallel, sell electricity to close-by communities. Another Potential investors are looking for both a strong business case approach could be to supply rural government institutions such and a great story about potential development impact; rarely is as agricultural extension facilities, clinics, schools, and possibly the latter sufficient for consistently attracting capital, even from railway installations with power on a contract basis and then to impact investors. Hence, a well thought out commercial business build community mini-grid operations around such demand plan is fundamental to securing financing, and, fairly soon after centers. Or they could provide power on an offtake agreement they get going, smaller firms should also think about how best to to existing mini-grids, for instance, remote systems operated by professionalize their management teams to ensure that they take the central utility. This would allow the central utility to focus the business forward and help it grow. on increasing connections rather than adding off-grid capacity, Larger companies making tentative forays into the market and likely reduce overall costs of operations if it were based on should ensure that such ventures are given the required resources renewable energy rather than diesel generation. Contracts with and internal visibility. While they may begin below the top- any of these entities would need appropriate advance payments management radar screen, these ventures should quickly be or guarantees, and long-term agreements to serve multiple areas. showcased within the company—as a CEO-sponsored effort, If growth were to take off, mini-utilities would need to develop for example. They would do well to use this platform to leverage the right span of control over dispersed systems to manage the core competencies, from distribution to procurement, across the operating complexity and resulting overheads that typically come business. And, here too, capital and strong management skills are with running several dispersed systems. One idea that could needed for them to grow. So, an initiative may be incubated in the help businesses scale efficiently is an “umbrella company” that corporate social responsibility department, or another “soft start” plays, among other roles, a contract negotiation and governance area of the business, but cannot be allowed to remain there. Once function, assists in raising financing, provides resource assessments sufficient time has been given to nurturing an innovative model, it and strategic planning advice, and procures equipment centrally. must be treated commercially and resourced accordingly. For grid-based utilities, the basics fundamentally mean being fit for purpose, which is achieved by enhancing system efficiency. This begins with investing in reducing both technical and nontechnical Rethinking policy: Roles for losses. While the skills and access to capital that have led to large- governments and their development scale grid extension in some countries will take time to replicate partners in others, many more straightforward tactics can be employed universally. These center on preventing theft, managing payment For policymakers—that is, governments and the development risk, and introducing flexible payment options. Utilities in partners with which they work—leveraging business as far Brazil, Colombia, India, and Uganda provide evidence that such as possible to increase energy access should be a priority; measures can lead to enhanced utility commercial viability and, this strategy would allow public funds to be directed toward in turn, (often aided by smart subsidies), increased connections reaching the “last mile.” As the examples in this report show, for the poor. conducive policy can help to attract the private sector to all three energy access markets. This means that household-level To succeed over the long term, companies need to play to their systems and mini-utilities should be recognized in policies strengths and build a compelling business case—and a strong as good options, and be fostered accordingly. It also means development story—and should consider professionalizing their that the private sector should be seen as part of the solution; management teams in order to secure financing and grow their development imperatives and profits need not be incompatible. businesses. Smaller companies, especially those that are locally If policymakers encourage business to address a sizable portion run, have several advantages. They are often nimble and have of the access gap, they can concentrate their own limited public low costs, good knowledge of the market’s product preferences funds on those segments of the population that can only be and ability to pay, and have customer reach through innovative served through public means. Meanwhile, in order to ensure networks. Larger firms typically have deep pockets; broader economic efficiency, those public funds that the private sector management expertise; and some value chain advantages accesses would be limited to closing the “viability gap”—that including procurement, convening power, and the ability to scale is, the shortfall between revenues that customers are able to across geographies. But this alone is not enough to be a successful contribute and those needed for enterprises to be financially player in the long term. Given that many start-ups (especially workable. EXECUTIVE SUMMARY 18 While energy access can, in many instances, be a complex mechanisms put into place to ensure that concessionaires are political issue, policymakers would do well to resist giveaway each implementing their part of the bargain as promised, or programs and unrealistic promises where markets exist. First, alternatively, allowing for regulatory counterparts to adjust smart subsidies can be an invaluable tool for providing services contracts where this is below par. to the poor. But, carelessly thought through “giveaways” can distort the market and limit the success of otherwise commercially viable offerings. Customers who are willing and Refocusing financing: Opportunities able to pay the full price for a product or service will of course hesitate to do so if they know that others received a giveaway for impact and commercial investors and that they may be next to enjoy this benefit. Second, if they Investors can play a strategic role in helping to catalyze commercial favor certain types of products, giveaway programs risk stunting approaches to improved energy access. Commercial lenders, social innovation and encouraging companies to manufacture venture capitalists, local development banks, philanthropists according to specifications that are not always optimal for and international development agencies would do well to keep the market. Finally, free products also deter businesses from investment mandates broad and beyond a single technology. This investing by creating risk that they will have to compete with will attract a wider selection of promising companies to invest giveaways. in and build a stronger portfolio. Investors should also establish deal marketplaces and local presence to discover hidden gems. Policymakers should consider removing discriminatory import Without these, it will be difficult to identify those lower-profile tariffs across energy access products. This report illustrates the companies that hold great promise—many of which may initially ways in which many governments impose penalties on modern be community-level efforts. energy access products that are higher than the duties and taxes on conventional energy products. Often the effects are First, financing from both impact and commercial investors is discriminatory and perverse, creating a bias in energy provision needed at various stages of the business life cycle. In the energy toward a better-off grid-connected population and away from access industry, there are roles for impact investors (particularly poorer households, and toward conventional rather than at the earlier stages) and commercial investors (especially for renewable generation sources. Countries that have instituted growth capital), but these should be directed at the needs of successful renewable energy access programs have typically the investable companies. While innovators often start as social relied on removing such tariffs. ventures, they have the potential to become sizable double bottom line companies.1 For mini-utilities, there are a number of supportive policies that can be implemented, including rethinking service areas, But to do so, they need help from impact investors to become instituting appropriate “light-handed” regulation, and creating bankable. Support could take the form of start-up grants, a solid revenue framework for firms. Rethinking service areas concessional financing at attractive terms, or loan guarantees involves being clear on where potentially competing grid to allow firms to borrow from commercial banks, for example. extension projects will head, and relaxing exclusivity on who Alternatively, support could be used to guarantee revenue can operate in other areas. Instituting appropriate “light- streams, for instance from large but perhaps less creditworthy handed” regulation means streamlining requirements for SMEs offtakers, such as entities that serve as anchor clients for mini- operating mini-grids, instead of applying rules in this subsector utilities. Given the difficulty in identifying and assessing that were originally designed for large utilities. Creating a solid individual companies, it would make sense to channel revenue framework for companies means establishing market programmatic monies via wholesaling mechanisms: this pricing for mini-utility tariffs, subsidizing connection costs means that impact investors should work with intermediaries where needed to close the viability gap and, if appropriate to the that are set up specifically to support a portfolio of energy business model, helping to manage payment risks for service access businesses rather than attempt to cherry-pick “winning contracts with large offtakers, including incumbent utilities companies” themselves. Commercial investors should then that buy excess power. address deal size, especially the “missing middle,” typically between $50,000 to $100,000 and $3 million to $5 million, For grid-based access, public-private partnerships such as while providing both debt and equity at the start-up phase and concessions hold the potential to extend reach when they are throughout the company life cycle. In this market, there is also carefully structured with incentives to connect end users. For a particular need for trade finance and carbon prefinance (to grid access to be successful, service areas need to be prioritized, support the carbon credit registration process, and front-load subsidies structured to cover viability gaps, and delivery payments for emissions reductions) for many companies. 19 EXECUTIVE SUMMARY Second, both investment and enterprise development support are fundamental to company success. Hence, at the individual company level, funds for business model refinement and management capacity building should be coupled with financial investments. The goal should be to help executive teams implement organizational structures and operating approaches and to develop robust growth strategies that allow the business to really scale. This is a model common in venture capital firms, which provide early-stage firms with active guidance designed to ensure that the investee delivers a suitable return. At the subsectoral level, donors can also help to support the design and testing of business models for companies operating at the frontier in energy access where there are difficult opportunities with high potential. This is the case, for instance, in the mini-utilities subsector, where profitable businesses have difficulty growing beyond a few isolated systems. Impact investors could potentially help to demonstrate proof of concept of scalable models by partially funding an umbrella firm setup or franchising plan. Third, donors can help reduce first-mover costs by addressing public good issues, namely providing market intelligence and information on the availability of resources and helping to build consumer trust and awareness. As with all emerging sectors, there are high first-mover costs in the nascent energy access space. Certain critical inputs to the development of a business venture may be prohibitively expensive to secure. Many such inputs can also be seen as public goods. These include collecting information on the availability of resources (such as biomass or hydropower potential) needed by mini-utilities, and gathering market intelligence on local customer spending patterns and preferences to help device players refine offerings. The same is true for building consumer awareness of and trust in new technologies, and putting into place appropriate standards to ensure that high-quality products enter the market as a whole. Finally, it is important to have effective institutional capacity to deliver on energy access targets. Governments sould consider establishing “delivery” units specifically tasked with managing the rollout of targeted energy access efforts including, as applicable, market-orientated programs to stimulate device uptake, mini-utility development, and grid extension programs. Effective local standards agencies for device manufacturers and regulatory bodies to manage mini-utility power purchase agreements or large electrification concessions are also needed. These areas can all benefit from donor funds. EXECUTIVE SUMMARY 20 ABOVE: MODERN ENERGY ENABLES SIMPLE TASKS SUCH AS COLLECTING WATER AFTER DARK (CREDIT: IFC) 21 CHAPTER 1 Chapter 1: Introduction ABOVE: MODERN GRID-BASED ELECTRICITY DOES NOT ALWAYS REACH RURAL PRODUCERS SUCH AS THIS GRAIN MILL (CREDIT: IFC) INTRODUCTION 22 In a world where an estimated 1.5 billion people live without electricity, and almost 3 billion do not have clean fuels for cooking, access to modern energy is a development imperative. It has been well documented that without electricity and efficient cooking and heating options, economic activity is curtailed and advancement toward the Millennium Development Goals is constrained—particularly in meeting health, education, and local environmental targets. Children cannot study well at night, and overturned kerosene lamps used for lighting can cause deadly house fires. Indoor air pollution associated with cooking on open fires and inefficient stoves is responsible for an estimated 2 million deaths each year—more than the number of deaths from malaria. People are deprived of information, communication, and entertainment. Productive enterprise—from small-scale manufacturing to service businesses—is stifled. Forests are harmed by the unsustainable collection of fuel wood and charcoal production for use in rural and urban households. The global extent of the problem is illustrated in figure 1.1. N/A 50%–75% < 25% 75%–90% 25%–50% > 90% Figure 1.1: Share of people without access to modern energy in 2007 Source: Legros et al. 2009. Note: Based on UNDP’s classification of developing countries and the United Nations’ classification of least developed countries. Modern energy refers to electricity for lighting and clean fuels for cooking. Populations typically rely on kerosene for lighting and biomass or charcoal used in unimproved stoves or in traditional fi res for cooking. N/A = not available. Several useful reports have made the case for universal access to modern energy,2 estimated what it would cost, and explored how delivery could be financed.3 Most recently, the International Energy Agency estimated that the annual cost of achieving universal energy access would be $48 billion. Using a base case, they sized the gap between expected costs and available funding at $34 billion annually.4 This is one-quarter of total overseas development assistance (ODA)5 of $129 billion, 30 percent more than all ODA to Sub-Saharan Africa of $25 billion, and five times the $7 billion in public investment (from developing country governments, ODA, and multilateral agencies) in energy access in 2009. Because it is unlikely that public monies alone can close the gap, the private sector is increasingly being called upon to be part of the financing solution. 23 CHAPTER 1 Reframing Energy Access as a Market While the socioeconomic rationale is clear, the business case for private investment in energy access has not always been apparent. As with many other infrastructure services, a public sector mindset has often dominated the energy access debate. Pilot projects in remote areas have proliferated while commercial solutions have generally not been encouraged. Moreover, well-intentioned but sometimes badly designed or unnecessary donations from governments, philanthropists, and development agencies have often scared entrepreneurs away. And, where businesses have taken root, more often than not they have struggled. Information on consumer willingness to pay is scant. Technology costs have been high and distribution networks weak. In some cases, legal and regulatory frameworks have been inappropriate and requisite financing for new ventures not readily available. In addition, motivated entrepreneurs have not always understood “base of the income pyramid” (BOP) markets or had the skills to succeed in or scale their business operations. This report finds, however, that a convergence of exciting trends is set to reignite business interest in the energy access market. It is not surprising that, until very recently, there has only been scattered business activity in the energy access domain. But several parallel developments are reshaping the debate, including the emergence of new technologies and declining costs of existing ones such as PV (photovoltaic) panels, LEDs (light-emitting diodes), and batteries; increasing fossil and cooking fuel prices that are forcing innovation; recognition of the critical relevance of the access agenda to the Millennium Development Goals; and the rise of social entrepreneurship and impact investing. A growing number of entrepreneurs are demonstrating—often at a relatively small but rapidly rising scale—that profitable ventures can indeed be built in low-income markets. Both local SMEs and conglomerates are succeeding in selling modern lighting and cooking devices, off-grid electrification and, to some degree, grid extension services to the BOP. Ambitious international start-ups are also emerging, particularly in the household energy devices space. There has been an appetite among some large multinational companies to expand their markets to the poor, too— and not solely as part of their corporate social responsibility efforts. Some firms in the devices and mini-utilities markets are making 10 to 30 percent profit margins. Promisingly, financiers are starting to express interest, with both commercial venture capitalists and impact investors making some tentative but high-profile and potentially instructive plays in the past two years. And there is mounting evidence that enabling ecosystems—the legal and regulatory frameworks within which the private sector operates—can be improved and donor interventions structured in such a way as to nurture businesses. This report’s analytical framework covers both the business operating model and the wider ecosystem. Figure 1.2 illustrates how we examine each step of the value chain to identify the success factors and areas where the greatest challenges lie and assesses ecosystem conditions that hinder or support profitable business activities. “In this report we examine each step of the value chain to identify the success factors for businesses. We also identify the ecosystem conditions that hinder or enable profitable private enterprise.” INTRODUCTION 24 Supply of cooking Development of Creating awareness Finding customers Collection of Providing a means fuels, procurement product or service of new offerings and delivering the revenues from to reduce the of fuels/feedstock offerings for the product or service customers, product up-front cost of for mini-utilities or market payment, or fee for purchase central utilities service Design / Production / Sales & Billing / Consumer After Fuel R&D Generation Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance Tariffs, legal Manufacturing of Accessing Using public Service, Securing income requirements, and products or investment and monies to break maintenance, and from carbon credits other generation of working capital to even or produce repairs policy-related electricity fund growth and profits factors operations FIGURE 1.2: Analytical framework used to study companies operating in the energy access market Source: IFC analysis. Other sectors are already actively exploring the market potential of consumers at the BOP, and there is much that can be learned from these innovations. Multinational corporations such as Unilever and Danone are selling shampoos, nutritional complements, and consumer goods to poor households. Social ventures have created innovative and affordable healthcare solutions. These include Aravind in India, which pioneered low-cost eye surgery using a high-patient-volume approach, and CFW shops in Kenya, which provide basic health care and prescription drugs to poor families using a franchise approach. Utilities such as Water Health International and Manila Water are serving rural communities at scale, while other businesses have experimented with bundling multiple utility services. There has, of course, been a proliferation of extensive microfinance products—from loans to insurance—over the last two decades across Africa, Asia, and Latin America. More recently, the mobile phone industry has confounded expectations by delivering huge growth among the poor. In 1998, mobile phone penetration in developing countries was just 1 percent. By 2010, it was 72 percent, and 65 percent in Africa, making it a larger market than Latin America. When the Nigerian government began encouraging competition in telecommunications in 2001, the country’s 140 million people (55 percent of whom live below the national poverty line) had 500,000 fi xed telephone lines. By 2007, there were 30 million cellular subscribers, and today there are over 93 million. 25 CHAPTER 1 Defining Ways to further Catalyze Commercial Success Stories Today’s energy access dynamics present a unique opportunity to further catalyze private sector action in the commercially viable portion of the energy access market, while focusing public resources on populations that cannot realistically be served by business. This report takes a fresh look at energy access products and services, based on recent market analyses of the BOP. Given that people are currently spending a significant portion of their incomes—often 10 percent or more each month—on basic energy needs, this is a proven, cash-based market. It is also, therefore, a huge opportunity for firms able to develop the right business models to capture it. Eschewing the more common development view, but recognizing nonetheless the importance of the public sector in advancing the universal access agenda, this report argues that policymakers and donors should direct a good portion of their efforts to catalyzing private sector action and helping it seize the market. The public sector can then refine its own focus to those populations that cannot be viably served by commercial actors. The energy Household access gap is level: Devices also a market and systems 1 Identify key Make opportunity success factors recommendations Study the Community - in the business approaches to level: model For business Size the market serving the Mini-utilities market 2 For policy makers Identify key Centralized: success factors Grid extension in the ecosystem For investors conditions FIGURE 1.3: Scope and methodology of the report Source: IFC. INTRODUCTION 26 About this report This report is intended for business decision makers, policymakers, and impact and commercial investors. It covers the areas of the energy landscape that present an opportunity for making a profitable business out of extending energy access to the poor (that is, those who earn less than $2 a day). The scope of the report (see figure 1.3) is global, covering developing countries in Africa, Asia, and Latin America, where many people do not have access to modern energy. While there is a range of energy services that people need—not least energy for productive uses—and various solutions available to meet these needs, this report focuses specifically on technologies and services that provide improved lighting, or “lighting plus” (primarily lighting but solutions that can generally also avail other electricity-related services) and cooking for the household market. Three solutions are considered for lighting: (a) solar lanterns, solar kits, and rooftop solar home systems; (b) electricity supplied by mini-grids operated at the community level (which we term “mini-utilities”); and (c) electricity supplied through grid extension from a central utility. In the cooking space, we review improved biomass cookstoves. The rationale is that the greatest growth and innovation appears to be in these offerings, with fairly large numbers of businesses starting to operate at scale. In addition, based on current cash expenditures and from a levelized cost perspective, they are affordable to a sizable portion of those people currently relying on traditional energy. The report is laid out as follows. Chapter 1, the introduction, discusses energy access as a market and defines ways to further catalyze commercial success stories. Chapter 2 explores how companies are serving the market, with an in-depth analysis of energy devices, mini-utilities, and grid extension. Chapter 3 discusses what can be done to help scale-up energy access success stories, with an emphasis on refining business models; rethinking policy and the roles of governments and development partners; and refocusing financing, including a discussion of the opportunities for impact and commercial investors. Our approach has been to first estimate the “size of the prize,” or revenues that could potentially be generated; this provides the market size. Next, we study what the private sector is already doing and what can be learned from its successes. To do this, extensive interviews were undertaken with a range of companies active in this space and with the organizations that support them. Secondary research provided additional data on selected case studies. Having gained this insight, our analysis identified the factors attributable to the businesses themselves and those attributable to the environment in which they operate. We then distilled the key success factors into a set of recommendations for business, policymakers, and social and financial investors. 27 CHAPTER 2 Chapter 2: Sizing the Energy Access Market ABOVE: KYA SAND, A PERI-URBAN SLUM NEAR JOHANNESBURG, SOUTH AFRICA, WHERE FORMAL HOUSING HAS BEEN ELECTRIFIED BUT INFORMAL DWELLINGS EXIST OUTSIDE OF ELECTRICITY SUPPLY (CREDIT: TERRESTRIAL) SIZING THE ENERGY ACCESS MARKET 28 Poor households spend about $37 billion6 annually on “traditional” energy, representing a major opportunity for businesses to reroute existing expenditure to safer, cleaner, and more cost-effective solutions. We estimate that the base of the pyramid (BOP) currently spends about $18 billion annually on lighting and charging services for small appliances. Other figures range from $10 billion in Sub-Saharan Africa7 up to $36 billion in global sales of kerosene used in simple wick or larger hurricane lamps to illuminate homes, workplaces, and community areas. An additional $19 billion is spent annually by many of these same households on wood and charcoal for cooking and heating on inefficient stoves and fireplaces. This $37 billion in annual energy purchases constitutes a sizable market.8 Some analyses put the amount spent at 10 percent of a household’s monthly cash outlays. Figure 2.1 summarizes current expenditure patterns for traditional fuels, illustrating the distribution of monthly energy spending by number of households (cumulative) globally. 18 Monthly Expenditures on Lighting Plus ($, 2010) 25 Monthly Expenditures on Cooking ($,2010) 16 14 Population that could be theoretically 20 served by improved cooking solutions Population that could be theoretically served by improved lighting solutions 12 15 10 8 10 6 4 5 2 0 0 50 100 150 200 250 100 200 300 400 500 Cumulative Off-grid Households (million, 2010) Cumulative Traditional Cooking Households (million, 2010) Lighting Plus (lighting and charging services) Cooking Fuels FIGURE 2.1: Distribution of household expenditures on traditional energy Source: IEA 2009; IFC-WRI 2007; UN 2011; UNDP/WHO 2009; Demographic and Health Surveys, ICF Macro, various years; and National Sample Survey Office, India 2005. How many people could afford to purchase better energy products and services instead? This question must be answered separately for each of the two broad types of energy relevant to this report: electricity and thermal energy. First, there is the market for modern lighting devices and small appliance-charging services—what we refer to in this chapter as “lighting plus.” Modern lighting uses electricity, even if powered from a solar cell. Solutions that offer lighting often provide additional household electricity. This is obvious for grid- or mini-grid-based electrification. But even fairly simple lighting devices now allow charging of mobile phones (which have high penetration even in poorer parts of the world) and other small appliances. Modern energy solutions—be they devices or power supplied by mini- grids or central utilities—could replace spending on traditional lighting and small electricity expenditures, such as on kerosene, candles, disposable batteries, and battery-charging services. 29 CHAPTER 2 Second, there is the market for improved cooking devices. The baseline for this segment is the money currently spent on fuels that provide thermal energy for cooking, specifically charcoal and wood. Charcoal is mainly used by urban households and traded on a cash basis. Wood, however, is much more common in rural households, which collect much of the fuel themselves. For the addressable market, (that is, the revenue opportunity available for a product or service), only cash purchases are considered as expenditure for wood. Our rationale is that, while it often takes a significant amount of time to collect firewood, this time or opportunity cost cannot be easily converted into cash, and therefore it is difficult to assume that it could be diverted to purchasing improved cooking devices or fuels. “Lighting plus” alternatives can be broadly categorized into three groups: (a) solar and rechargeable lanterns, (b) “plug-and-play” solar kits, and (c) modern electrification solutions covering rooftop solar home systems or a connection serviced by a mini-grid or central grid. Figure 2.2 describes various technology solutions. Simple solar and rechargeable lanterns start at an up-front retail price of $6 to $20 and can be commercially provided at a levelized monthly cost of around $1.25. “Plug- and-play” solar kits power several lights and small appliances and offer better energy storage; these start at a monthly levelized cost of around $5.50. Finally, more holistic electricity solutions (rooftop solar home systems and, where available, connection to decentralized mini-grids or a centralized grid) start at monthly levelized commercial costs of around $8 to $9. Improved cookstoves Solar and rechargeable lanterns Solar kits Cookstove with higher efficiency Integrated device combining small Plug-and-play system including and lower emissions, using biomass solar panel, batteries, and typically portable solar panel, batteries, (wood, charcoal, other processed LED lights; sometimes offers limited multiple lights, and sockets for solid fuel) external charging, e.g., cell phones. running small appliances, e.g., black Also covers rechargeable lanterns and white TV, radio Solar home systems Mini-grids Grid extension Fixed installation, typically on Small generation facilities using Extending access from the national rooftop, provides good storage of a diesel, biomass, hydro, wind, or solar electricity grid to communities in few days, can run lights and with distribution network to a local urban, peri-urban, and rural areas appliances, e.g., refrigerator, TV, fans community FIGURE 2.2: Energy access solutions discussed in this report Source: IFC 2007. Photo credits: First Energy; Sundaya; IFC; Terrestrial; and Greenlight Planet. SIZING THE ENERGY ACCESS MARKET 30 Improved cooking appliances fall into two main categories: those based on biomass (wood, charcoal, or processed briquettes), and those using more advanced fuels. Most improved cookstoves are based on easily available biomass fuels. They start at a commercial cost of around $5 up front (or a levelized cost of around $0.40 per month) and, owing to enhanced efficiency, can save a family 30 to 50 percent per month in fuel costs. Households spending as little as $0.90 for wood or $1.30 for charcoal could afford to purchase a cookstove based on these expected monthly fuel savings. The other category is for cookstoves that use more advanced fuels, notably pelletized biomass, kerosene, and liquefied petroleum gas. In the case of improved fuels, the more economic cookstove and pellet combinations cost around $9 a month (including fuel costs), while more expensive kerosene or liquefied petroleum gas variations range from $15 to $30 a month. Our analysis shows that more than 90 percent of households without access to clean lighting and cooking solutions could afford improved products and services, since they already spend more on traditional energy than the commercial cost of superior, more modern energy. Based on current spending patterns and the cost of modern alternatives, some 256 million households could afford improved “lighting plus” and 394 million could afford cleaner cooking solutions. As indicated in figure 2.3, these households spend more than $1.25 each month on “lighting plus” and over $1.30 each month on wood and charcoal for cooking. The theoretically addressable market can be segmented into a range of available modern energy options depending on how much various groups of consumers can afford to pay. As shown in figure 2.3, and described in greater detail in Appendix A, the market for “lighting plus” is split into solar lanterns and lanterns that are charged by community- or village-level solar cells or other forms of energy (but not disposable batteries), solar kits, rooftop solar home systems, mini-grids, or grid-based electrification. The cooking market is divided into cleaner-burning cookstoves that use charcoal and wood, and more expensive stoves using improved fuels. Households without modern lighting & electricity Households cooking with traditional biomass Total = 274 million Total = 426 million 18M 112M 86M 58M 32M 374M 20M 100 100 Rooftop Not commercially adressable SHS 80 80 Not commercially adressable Alternative Fuels** Grid % of Households % of Households Extension Charcoal/wood 60 60 Improved Cookstoves - Wood Solar & Rechargeable Solar Lanterns kits 40 40 20 20 Mini- grids Improved Cookstoves – Charcoal 0 Less More 0 $0.90 (wood) to $1.30 (charcoal) and $9* Less $1.25 $5.50 More than than than to to than $1.30 Monthly household spending on traditional energy $9 $1.25 $5.50 $8.50 $8 *The lower bound for monthly spending on wood (~0.9) is below the charcoal Monthly household spending on traditional energy limit (~1.3) because the efficiency gains from wood-fired improved cookstoves (~40%) are higher than the efficiency gains from charcoal cookstoves (~30%). **Alternative fuels include pellets, LPG. FIGURE 2.3: Theoretically addressable market for “lighting plus” and improved cooking in 2010 Source: IFC analysis. Note: The segmentation of improved energy alternatives is indicative, reflecting current estimates of technology costs and pricing and how much households spend at the global level. This should not be interpreted as a fi xed market size for specific products or services, which is best determined on a country level using local technology costs and pricing and willingness and ability to pay. 31 CHAPTER 2 The addressable market is really a conservative lower bound as it is based on current cash spending on traditional energy and does not assume savings opportunities for the poor, or subsidies. Estimating the addressable market for access to modern energy starts with the total current cash expenditure on traditional energy. Then, using price ranges for various energy products and services, we approximate the number of households that could afford each “technology category” at current energy expenditure levels. Appendix A provides a more detailed breakdown of how the market size was calculated and key assumptions. However, this market can also be described as “theoretically addressable.” Our calculations are based on levelized commercial costs, which assume an even distribution of the product cost over the entire life time of the product9 and no additional regulatory or other obstacles to uptake. The sensitivity section later in this chapter examines the impact of variations in key drivers and assumptions such as cost and willingness to pay. Capital cost, $ Capital costs per connection for mini-grids start at about $50 Mini-grids, and can increase to $300 or more, depending on the service Grid 2–7.5 level and distance from the system. The lower bound of $50 is 50–300+,500+ used for the threshold calculation. Grid extension to sufficiency extension 8.5 adjacent off-grid communities starts at approximately $500 and are used for the threshold calculation. Rooftop SHS 2–4 250–500 8.5 Solar kits 100–150 1.5 5.5 Solar lantern/ rechargeable 20–40, 6–20 0.5–1 lanterns 1.25 LPG (cylinder & 29 50–100 burner) 31 Pellet stoves 25–50 8 9 Improved charcoal/wood 5–25 0–7.1 stoves 0.8–8 10 12 14 16 18 20 22 24 26 28 30 32 2 4 6 8 Operating costs per month ($) Levelized monthly cost to the end-user ($) FIGURE 2.4: Commercial price of modern energy alternatives Sources: IFC analysis based on Demographic and Health Surveys, ICF Macro, various years; IEA 2009; IFC-WRI 2007; UN 2011; and UNDP/WHO 2009. SIZING THE ENERGY ACCESS MARKET 32 Devices and household-level systems account for the lion’s share of the market, followed by mini- grids and grid extension. Based on current spending patterns and reflecting the aforementioned levelized cost ranges (figure 2.4), the potential addressable market is distributed unevenly across technology categories (figure 2.5). At an estimated $31 billion, the device and household-level systems market is the largest, followed by mini-grids at $4 billion, then grid access at $2 billion annually. That said, it is important to stress that this market size and segmentation is primarily derived from current cash expenditure patterns of BOP energy consumers. Thus, it represents an immediately accessible market. Changing cost structures or consumer preferences, and the introduction of subsidies, could easily change this. Expected increases in income levels, possible further reductions in technology costs, increased consumer awareness of alternatives, and new business models for delivering them could all trigger demand for higher-end devices, for instance. It could also be assumed that targeted public-private financing structures would increase both the overall market size and the share of mini-grids or grid-based electrification solutions. Grid extension 21 Grid extension 2 Mini- Mini- Grids 28 Grids 4 Devices: Modular SHS 9 Modular SHS 1 Advanced fuel Advanced fuel 3 20 stoves stoves Solar lanterns 112 Solar lanterns 4 31 billion Solar kits 86 Solar kits 7 Improved Improved 16 374 biomass stoves biomass stoves 0 100 200 300 400 0 5 10 15 20 Households (millions) Market for modern energy services ($ billion) FIGURE 2.5: Theoretically addressable market by technology category Source: IFC analysis based on Demographic and Health Surveys, ICF Macro, various years; IEA 2009; IFC-WRI 2007; UN 2011; and UNDP/WHO 2009. Note: The segmentation of improved energy alternatives is indicative, reflecting current estimates of technology costs and pricing as well as household spending at the global level. This should not be interpreted as a fi xed market size for specific products or services, which is best determined on a country level using local technology costs and pricing and willingness and ability to pay. SHS = solar home systems. “At an estimated $31 billion, the device and household-level system market takes the lion’s share, followed by mini-grids at $4 billion and grid extension at $2 billion annually.” 33 CHAPTER 2 Besides huge market opportunities, closing the energy access gap could significantly improve the living conditions of millions of households around the world. If every family in the addressable market were to use improved technologies or solutions, an estimated 550 million kerosene lamps would be replaced by cleaner alternatives for lighting, and 400 million families would be using at least improved biomass cooking devices. As a result, around 250 million sick days and 800,000 premature deaths related to indoor air pollution from traditional lighting and cooking fuels would be avoided each year. About 300 million metric tons of carbon dioxide emissions would be mitigated, mostly from a decrease in deforestation owing to fuel savings. (See Appendix B for details on the impact of improved energy access.) Key market drivers and sensitivities Certain drivers affect the extent to which the theoretically addressable market is adjusted to a “likely addressable” market. A sensitivity analysis shows that the up-front cost of products and services, and the customer’s willingness to pay are the most significant drivers of the market size. The impact of regulatory changes is an important factor, too. For simplicity, we estimate the impact of tariffs and duties assuming the same effect as price increases or the introduction of additional up-front cost elements. Addressable households (millions) 120 100 80 60 40 20 0 Base case 0 10 20 30 40 50 60 70 80 90 100 Up-front payment as % of commercial cost (the remainder being distributed over time in form of levelized cost) Solar and rechargeable lanterns Solar kits Solar home systems Mini-grids Grid extension FIGURE 2.6: Sensitivity of the addressable market to up-front cost Source: IFC analysis. SIZING THE ENERGY ACCESS MARKET 34 Up-front costs The addressable market estimate assumes that costs are broken down into monthly payments; the estimate would be much smaller if users were required to pay the total cost up front. The addressable market base case is a function of the levelized monthly costs of a product or service. If payment of a product or access to a service were required up front, the addressable market would be much smaller than if users were allowed to spread them over time. It is precisely to address this up- front payment sensitivity that companies around the world offer leasing options, consumer loans, and other means of paying off costs over time. Figure 2.6 shows the impact of increasing up-front costs on the theoretical market size. In the case of solar lanterns costing $20 to $50, for example, a required down payment of 20 percent would reduce the addressable market by about the same amount, dropping this by 13 million households to 90 million households. For solar kits, a 20 percent down payment would more than halve the addressable market, reducing the number of households that could afford this technology from about 90 million to just under 40 million. A 10 percent down payment halves the market for solar home systems, reduces it by about one-third for mini-grid connections, and virtually eliminates it for grid-based electrification. In reality, however, it is difficult to know just how much people can afford. A very imperfect understanding of poverty and consumer spending has been demonstrated time and again in the design of social and economic development programs, product pricing, and company go-to-market strategies. Nonetheless, as discussed in Chapter 3, energy access product retailers and service providers are starting to recognize the importance of designing product and pricing strategies to spread up-front consumer costs, so the subject is explored here. Some utilities waive the initial connection charge and offer financing options that allow customers to spread cost over time. Solar home system suppliers frequently bundle microcredit with their offerings, thus reducing the need for large up-front payments and amortizing a significant portion of the costs over time. For cookstoves or solar lanterns, which are smaller-ticket items, hire purchase,10 recharging services, or pay-as-you-go models are sometimes offered to maximize market penetration. Willingness to pay A customer’s willingness to pay for a good or service is the second key driver for the addressable market estimate, and is based on customer awareness, expectations, and, critically, the perceived value of energy solutions. Customer education on the benefits of modern technologies, valued extra features (like phone charging), product performance guarantees, and social recognition can all increase willingness to pay. These are some factors that can be targeted by businesses, policymakers, and donors. But other factors such as hard-to-predict customer spending choices, affect willingness to pay and, therefore, the market penetration of a product. The growth of mobile telephone sales across the developing world has shown that the poor can often find a way to pay for something with perceived value, or something that they simply desire. Less than a decade ago, the billions of people living on $2 a day barely appeared on the radar screens of mobile phone operators. Today, they are a critical market and a rapidly growing part of corporate revenues. Handsets costing $20 to $50—well within the range of low-cost clean energy devices—can now be found in very remote areas, and are overwhelmingly purchased without credit from the retailer or subsidies from donors. 35 CHAPTER 2 A change in willingness to pay has the largest impact on the market for more expensive products. The base case estimate uses a conservative assumption that households would be willing to spend on modern energy solutions what they could save by switching from traditional energy. The sensitivity analysis in figure 2.7 illustrates the impact of changes in willingness to pay on the size of the addressable market, showing that the largest impacts are on more expensive products on a levelized basis. A 20 percent increase in willingness to pay for solar home systems, for example, could increase the addressable market by roughly 60 percent. 140 Addressable households (millions) 120 100 80 60 40 20 0 120 110 100 90 80 (base case, %) Willingness to pay (in percent of current spending on traditional energy) Solar and rechargeable lanterns Solar kits Solar home systems Mini-grids Grid extension FIGURE 2.7: Sensitivity of the addressable market to willingness to pay Source: IFC analysis. Precedents for market capture The estimates above suggest that the addressable unserved market is significant: 374 million for improved cookstoves and fuels and 256 million households for lighting solutions, most of which also offer broader energy services. However, given the challenges linked to selling almost any product to the poor, these estimates of potential customer numbers clearly do not directly translate into sales forecasts. It is virtually impossible to foretell the commercial success of modern energy services given the complex drivers involved. But some broad trends and indications can be derived from other global sectors and from certain national markets where energy access technologies are starting to take off. Figure 2.8 shows the speed of penetration of new energy technologies and business models into a number of national markets in developing countries and the spectacular growth of mobile telephony subscriptions in developing countries. While the explosion of access in telephony does not predict the same path for energy services, it does indicate that customers in hard-to-reach areas can be served, even through capital-intensive delivery systems such as mini- grids. GSMA, the international association of mobile phone operators, estimates that there are around 550 million off-grid subscribers in rural areas. New mobile base stations are routinely added, and GSMA estimates there will be about 639,000 off-grid systems by 201211 across rural areas in the developing world. SIZING THE ENERGY ACCESS MARKET 36 100 On- and off-grid electrification - Morocco Guatemala Utility Case – Electrification 80 % of households 60 On-and-off grid electrification - South Africa 40 Mobile subscriptions – Developing countries Solar lanterns – Kenya Solar home systems – Bangladesh 20 Minigrids – Cambodia 0 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 FIGURE 2.8: Penetration rates of energy and mobile phone services in developing markets Source: IFC analysis. The success of modern energy access at scale in certain countries indicates that it is possible to capture the unserved energy market under the right conditions. Take solar home systems in Bangladesh, for example. In 2000, penetration of the addressable market was less than 1 percent. Ten years later, about 1 million systems have been installed, reaching 40 percent of the addressable unelectrified population by blending concessional loans and consumer payments, and leveraging private sector companies to manage operations. Countries like Morocco have achieved essentially universal electrification using a combination of grid extension and SHS, delivered largely in a commercially viable manner. Consider also mini-utilities in Cambodia. After a little more than 15 years of development, mini-utilities serve 28 percent of the rural population on a commercial basis. Toyola, the Ghanaian cookstove company, has seen rapid growth in annual sales since beginning formal operations in 2006, and is now serving 30 percent of its addressable urban market with approximately 150,000 units sold benefitting around 750,000 people. Replicating this kind of success across rural Africa and South Asia, where the majority of people without access to modern energy reside, would translate into enormous impact and business potential. As the examples in Chapter 3 will show, where good business models meet appropriate financing and enlightened policy, rapid penetration of the market is possible. In summary, while it is clearly naïve to assert that the entire addressable market can be captured, it would be equally imprudent to assume that the conditions for viable commercial ventures can never be met. “Where good business models meet appropriate financing and enlightened policy, rapid penetration of the market is possible.” 37 CHAPTER 3 Chapter 3: How Companies Are Serving the Market ABOVE: THREE-STONE WOOD FIRE, NAMPULA DISTRICT, MOZAMBIQUE (CREDIT: SETAR) HOW COMPANIES ARE SERVING THE MARKET 38 Broadly speaking, basic energy needs can be met through household-level devices and systems, community-level mini-grids, and grid extension. Household-level devices and systems—covering cooking devices, solar lanterns, and solar home systems—offer a first step up the energy ladder. While generally suited only to a limited number of tasks, they are often the most cost-effective option for the dispersed rural poor, and for many families living in urban slums. Community- level systems—mini-grids that serve from a dozen to several hundred households—provide electrical energy to power lights, appliances, and, beyond the home, small manufacturing and commercial firms. The “mini-utilities” that operate such systems serve customers often for much less than they currently spend. Finally, grid extension provides a more comprehensive solution, typically supplying enough energy for electrical and cooking needs. In addition, the grid can provide energy for productive purposes which, over time, enable socioeconomic development. Over the years and across geographies, a range of approaches has been employed by the public and private sectors for providing the unserved with such modern energy alternatives. In some cases, focused national policy has led to the extension of the power grid to remote communities, or the installation of village-level systems, almost exclusively funded through the public purse. In other cases, appropriate consumer demand and ability to provide appropriate offerings have led to entrepreneurs selling energy products and services profitably. There are also many instances where energy access activities occupy a middle ground of “quasi-commercial.” Here, companies may have to spend excessively on raising consumer awareness about a new technology, or they might even make a deliberate decision to charge subcommercial prices or rates for a product or service based on a social responsibility aim. In many cases, the difference between the cost of providing a service and the target consumers’ willingness or ability to pay is what limits a firm’s commercial returns. These ventures would be profitable under slightly different circumstances or with some grant support, given that they otherwise embody the elements of an efficient private enterprise. This chapter focuses almost exclusively on what we term “commercial, enterprise-based” approaches to serving the market for energy access. These businesses operate primarily or entirely with a profit motive, and are already considered commercially viable or are on the cusp of becoming so. In some instances, notably in the mini-utilities and grid-based electrification subsections, we explore particularly interesting quasi-commercial business models. All case studies cover ventures that serve the poor as all or a significant part of their customer base, employ enterprise-based business models to deliver a product or service, have gone beyond the concept stage and are already operating at scale, and employ business models that we believe have the potential to grow further and be replicated under the right conditions. A selection of all of these types of businesses is shown in figure 3.1. 39 CHAPTER 3 ENERGY ACCESS Improved Solar Solar Home Mini-Utilities Grid BUSINESS Cookstoves Lanterns Systems and Extension MODELS and Fuels Solar Kits COMPARED Grameen Commercial, Tizazu, d.Light, Shakti, Husk Power, CODENSA, Ethiopia India India* Colombia enterprise- Bangladesh based Toyola, Sundaya, COMASEL, NEST DESI Power, (fully or nearly Ghana India Indonesia India Senegal* financially Greenlight North Delhi Servals, TataBP, VEE, viable; product Planet, Power India India Cambodia India Limited, India sales or Total, First Energy, Deng, PowerSource, Ahmedabad fee-for-service) India West Africa, Ghana Phillippines Electricity Indonesia Company, Paradigm, Soluz PV, REPRO, India Barefoot Dominican Kenya Power, India Rwanda Republic Moser Baer, Tecnosol, Batdeong, India Nicaragua Cambodia Nuru Energy, SELCO, Rwanda India Sanyo, Temasol, Kenya Morocco Fenix, Trony, Uganda, Kenya Rwanda Quasi- Envirofit, Philips Solar, ONE, Bonny Utility ONE-PPP, commercial India India Morocco Company, Morocco Nigeria (partially Katene Kadii, Schneider, PERMER, SEEDS, CEMAR, subsidized, Mali India Argentina Sri Lanka Brazil using CSR or PPP approach) GIRA, TERI, KES, CRERAL, Guatemala, Mexico India South Africa Brazil Distribution Company KSG, NuRa, Korayé PPP Osram, Tanzania Kenya South Africa Kurumba, Mali Non- Jiko Stove, Nepal South Africa Kenya Light Haiti, UNDP/GEF, Community commercial Haiti Botswana Utilities (primarily Bolivia Qori Q'oncha, USAID, World Bank, Vietnam publicly Peru Ethiopia Electrification Afghanistan Program funded; government or Practical China donors) Action, Peru Number of devices sold/customers ~10 000 ~50 000–100 000 250 000+ connected to the system: *IFC investee Company not reviewed in this report Households typically have 5 to 10 people, so total number of people reached is significantly higher FIGURE 3.1: Overview of selected energy access ventures – subsector, model, and customer base Source: IFC analysis. Note: Some mini-utilities listed as “commercial” receive subsidies to cover a portion of their capital costs or, alternatively, have access to government funding to cover a portion of connection costs to end users. These firms are considered to be commercial because they are operationally self-sustaining. CSR = corpo- rate social responsibility; PPP = public-private partnership. HOW COMPANIES ARE SERVING THE MARKET 40 Household-level Devices and Systems While most of the lighting players, even the smaller ones, take a multicountry or even global view of the market, local A range of household-level devices and systems has emerged entrepreneurs are much more prevalent in the improved in recent decades to meet the basic clean lighting and cooking cookstoves space. Companies like Tizazu in Ethiopia and needs of households around the developing world. This report Toyola in Ghana are profitably selling efficient artisan- focuses specifically on lanterns (largely solar lamps but also a produced charcoal and wood-burning cookstoves for $5 to $25. handful of innovative rechargeable lantern models that use solar Other firms are producing more advanced stoves (costing $25 or kinetic energy), solar home systems (SHS), and improved to $75), improved fuels, or both; these include India’s Servals biomass cookstoves, because these devices and systems have and BP spin-off First Energy (which sells a stove together with shown the greatest innovation and growth. These segments processed biomass pellets in India) and U.S.-based Envirofit. have seen the largest number of new entrants to the market or While they are not considered in this report, a number of local companies already delivering services at significant scale. businesses and multinational companies are creating innovative ways to sell liquefied petroleum gas in small-size cylinders Several hundred companies exist in the devices space—many (which make the cost of both the device and of refilling more of which are growing rapidly, reaching hundreds of thousands affordable) across urban centers in Bangladesh, Kenya, Nigeria, of customers and producing good profit margins. Device and Thailand, where charcoal is particularly expensive or where companies are often commercially viable because the retail price kerosene is used for cooking due to lack of a wood-based fuel of their products typically matches a few months’ expenditure supply. on traditional fuel and is thus either immediately affordable or can be made affordable by spreading payment over time. Some firms are reporting operating profit margins of 15 to 20 percent and returns on equity of 10 to 30 percent. However, the low product price also means that revenues are generally small, limiting the extent to which they are able to attract investors looking for big transactions. Across all technology categories, we see the greatest development in solar lanterns and improved cookstoves, where barriers to entry are typically low. Priced at $20 to $50, with some newer offerings as low as $10, solar lanterns are gaining popularity with the BOP as a cost-effective alternative to kerosene lamps because they are safe and clean, do not require the expensive disposable batteries that traditional torches use, are portable, durable, charge quickly, and provide illumination that lasts for much of the night between charges. Increasingly, lanterns designed especially for the needs of the poor also have built- in radios and allow for mobile phone charging—providing additional energy services that are of high and growing value to households. A number of nimble international start-ups have developed solar lantern offerings; they include Indian pioneer NEST (Noble Energy Solar Technologies); U.S.-originated but now India-headquartered Greenlight Planet and d.light design; and Australian-originated Barefoot Power, active in East Africa and India. More seasoned players—multinationals like Philips, Sanyo, Schneider Electric, and Total, and emerging market conglomerates such as India’s Moser Baer and TataBPSolar, Kerosene devices such as this unsafe stove are dangerous and China’s Trony—are also developing value propositions for (Credit: Terrestrial) low-income consumer segments. 41 CHAPTER 3 Solar home systems have a fairly long history among development institutions but are increasingly an energy access solution offered by local entrepreneurs. Modular rooftop PV (photovoltaic) panels use daylight to charge batteries that store this electrical energy for use in devices. Costing $300 to $500 for smaller units, solar home systems are a marked step up from lanterns because they provide more comprehensive energy services, powering from a few lights to several large appliances. Often found in predesigned combinations from 20 watts peak (Wp)12 to 150 Wp, with 50 Wp being a common size, they can also be designed according to specific users’ needs. Panels have the advantage of a 15-to-30-year life, with no operating costs as such, but must be installed by trained technicians and require regular maintenance. While SHS allow households to meet their electrical energy needs, even larger solar home systems are typically not an option for thermal energy, and hence other devices are required for cooking or heating (figure 3.2). Solar lanterns Solar kits Solar home systems Solar lanterns are single Solar kits comprise more Solar home systems are a devices with an associated than one light, offering larger PV panel, permanently PV panel to charge them. phone charging, radio, or installed on a roof or pole, additional lights. with various uses. TOP: d.light TOP: Barefoot Power TOP: Tecnosol MIDDLE: Kamworks MIDDLE: Duron MIDDLE: SELCO BOTTOM: Greenlight Planet BOTTOM: Sundaya BOTTOM: Sunlabob FIGURE 3.2: Solar and rechargeable technologies for lighting and providing electricity for the home Source: PV = d.light, Barefoot Power, Tecnosol, Kamworks, Duron, SELCO, Greenlight Planet, Sundaya, and Sunlabob. Note: PV = photovoltaic. HOW COMPANIES ARE SERVING THE MARKET 42 Some of the more notable examples of large-scale operations include Bangladesh’s Grameen Shakti; India’s SELCO, which has also ventured into Vietnam; and Soluz which has operations in the Dominican Republic and Honduras. These firms, along with others such as Ghanaian Deng and Nicaraguan Tecnosol, serve several thousand customers and operate largely integrated (and often diversified) businesses, providing end-to-end offerings that bundle system design, component assembly, rooftop installation, servicing and, generally, customer financing. Some private enterprises have been able to operate profitably without any subsidies. Rahimafrooz is a case in point. This leading Bangladeshi manufacturer of batteries has been supplying batteries to solar home systems for a while, but, seeing the growth of its orders, decided to begin selling panels, too. To date, the company has installed more than 120,000 home systems and achieved breakeven after six months of operation. However, subsidies have played a key role in helping to scale most solar home system businesses. In its business model, Grameen Shakti, for example, has leveraged favorable borrowing terms and regulations provided by the Bangladeshi government via IDCOL (Infrastructure Development Company Limited), which in turn enjoys concessional funding from international development institutions including the World Bank and Germany’s development bank, Kf W. Likewise, SELCO and TataBPSolar have also tapped sizable soft financing or subsidies from the Government of India. More affordable “solar-kit” technologies are emerging, expanding the reach of household systems. Solar kits are “portable solar home systems” that integrate panels, battery packs, and a charge controller with plugs for equipment. They power several lights, device chargers, and even small appliances such as a black-and-white television. Retailing at $100 to $150, they are more expensive than solar task lanterns but less than half the cost of a modular rooftop solar home system of similar capacity. They can also be bought off-the-shelf and do not need installation or much maintenance. Not insignificantly, they appear to be an aspirational purchase. Customers do not simply view them as a “collection of small lamps” to replace kerosene. Rather, solar kits seem to be seen as both a physical asset and a product for which many poorer people are willing to pay extra. There is early evidence of unexpectedly rapid penetration of solar kits in some markets.13 They are increasingly popular with manufacturers, and producers include Indonesia’s Sundaya, and U.S.-based Duron and Fenix International for the Indian and African markets, respectively. With an estimated size of $31 billion, the market is far from reaching its potential. While it is encouraging to see a plethora of innovative local and international firms serving the BOP, the devices industry is still nascent and highly fragmented. Players operating in this space are often small and dispersed, limiting their ventures for now to a few select geographic areas. Some choose to enter certain states in India where energy access rates are low or the presence of microfinance institutions is high, while others select African countries with high kerosene or charcoal costs. Partnerships at various points along the value chain—from supply of materials to high-quality manufacturing, distribution to working capital finance—that more established sectors can take for granted are still delicate. And, not immaterially, given that it takes time to secure strong cash flows, it is often difficult to keep start-ups with good ideas going long enough to become real businesses. So market entry, survival, and scale-up are not without their challenges. But companies able to address these hurdles should be well placed to take a share of the huge market opportunity. 43 CHAPTER 3 Larger Entities Emerging Market Conglomerates Have local capabilities and distribution to go with their scale Total (Africa, Indonesia) Sanyo D (Kenya) RMD TataBP Solar Philips Brand Builders (India) RMD (Africa) Integrate their value RMD n Moser chain to drive io Baer ut First distribution & scale rib (India) Energy ist RMD D (India) to RM D R& Trony om (Africa) Schneider fr RMD (India) n io RMD at gr te In h ig H o- Deng -t w (Ghana) Lo Local D Entrepreneurs Have good Zara Integrators Solar local context (Tanzania) Integrate their value knowledge D chain along their International core technology or Independents capability Have good Toyola (Ghana) design and M NEST Stovetec customer touch (India) Servals (Latin America) Sunlabob Smaller Entities RM (India) (Laos) RM RM d.light RM Tizazu (India, Africa) RM 'PXKTQƂV (Ethiopia) M Barefoot (India, Africa) (India) Duron RM (India) Greenlight Sun RM Anagi RM (India, Africa) Transfer (Sri Lanka) RM (Asia) Ugastove M RM (Uganda) M Local Focus Global Focus Stove companies Solar lantern companies Solar home system companies R R&D M Manufacturing D Distribution FIGURE 3.3: Characteristics of selected companies covered in this section Source: IFC analysis. HOW COMPANIES ARE SERVING THE MARKET 44 Devices: Business Models - How Integrators: Companies that work along the entire value chain, mainly as a function of their technology focus. They are able to Companies are Serving the Market combine technical fundamentals such as manufacturing and/ The business models adopted by device companies vary, but or installation of a system, after-sales service, and financing that they can be grouped loosely into the following four categories, helps customers manage the larger up-front cost of that system. reflecting the origins of these ventures and how they operate Most operate in the solar home systems market, but a handful along the value chain (figure 3.3). also sell stoves with processed biomass fuels. Local Entrepreneurs: Homegrown small and medium Brand Builders: Multinationals or established local enterprises (SMEs), which typically manufacture products conglomerates that leverage existing brand power in other from low-tech, locally adapted, or open-source designs. These areas, distribution chains, and sometimes manufacturing companies are mostly in the improved cookstove space, but capabilities to sell energy access technologies—covering one or have some presence in lighting. more of solar lanterns, solar home systems, and cookstoves— alongside other offerings. International Independents: Start-ups and smaller companies mainly with Western roots, which focus on the design and Figure 3.4 shows the analytical framework used in this report, marketing of a single product or segment and generally with a description of the activities of the companies in these outsource manufacturing and partner with other players categories along the value chain. As the report analyzes these for distribution. Primarily present in the solar lantern and firms along the value chain, it will show how these categories cookstove categories. differ in their approach to the market. Few players are Lighting players Brand Builders Varying degrees Some through Some companies ofHGTKPIURGEKƂE focus on in-house leverage their of integration of corporate funds have found fuels but some design, but some reputations, but distribution but most via low-cost ways to stove companies use Independents ƂPCPEGRCTVPGTU service manufacturers open source build the brand equipment offer both fuels (mainly from scratch and stoves cookstoves) Design / Sales & Billing / Consumer After Fuel R&D Production Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance Outsourced or Mostly impact/ Some companies Some companies Only now in-house double bottom use grant funds have innovative emerging as a depending on line investment to break ways to spread possible income, technology, skills, for now even or produce the up-front cost especially for and import profits stoves duties FIGURE 3.4: Devices - how companies are serving the market Source: IFC analysis. 45 CHAPTER 3 R&D and Design The R&D and design portion of the value chain usually focuses on ensuring affordability, and designing offerings to meet the specific needs or demands of the poor. This is an area of especially strong focus for International Independents active in the solar lantern market. Once seen as niche products for high-end campers, thanks to recent innovations, solar lanterns now offer the promise of cost-effective, high-quality, safe lighting for the poor. International Independents in the lighting space (and to some degree in cookstoves) generally have a strongly user-centric design approach, using extensive field research to understand customer needs, and applying those insights to inform the design of new, “BOP-appropriate” products. A number of entrepreneurs focused specifically on solar lamps have emerged from Western university research labs and MBA programs, and view themselves as pioneers in leveraging cutting-edge technology, design leadership, and savvy customer touch. d.light design is a good example. Founded in 2007 by a pair of young entrepreneurs in the United States but now based in India, d.light has developed two flagship products—a task lamp, and a wide-beam light that can also be used to charge a cell phone. Players in the emerging solar kit sector have taken a similar R&D-heavy approach. But there are also local companies with strong offerings. India’s NEST, started by a Delhi-based engineer and technologist with expertise in PV technology, designed the popular Aishwarya compact fluorescent lantern in 1999. Indonesia’s Sundaya, which has been working in solar home systems since 2009, used its knowledge of PV technology to develop the Ultium solar kit system in-house. Kamworks has also crossed over from experience with solar home systems in Cambodia to design devices such as its S20 to S80 solar lantern models. Both companies built on their experience in rooftop systems to craft new offerings specifically for poor rural consumers. With its founders coming from Silicon Valley’s high-tech cluster, where they focused on product innovation, Fenix International has been able to capitalize on strong in-house research, development, and design skills to develop an attractive $150 solar kit, the ReadySet. In the cookstoves segment, some International Independents use proprietary R&D and design, but many of the most successful players are local entrepreneurs that leverage open-source technology or country-specific designs developed through government or donor programs. The cookstoves area has been the subject of much research and international development assistance programming in the last decade. Taking advantage of designs initially developed or offered by universities, appropriate technology providers, or development agencies, many homegrown SMEs have begun to produce devices at scale—albeit often using artisanal methods—and to sell them commercially. This is the case for the Tizazu Stove in Ethiopia and the Anagi Stove in Sri Lanka, which combined government- and donor-funded development of a locally adapted design with training of artisans, who then began making the device commercially. First Energy, which started as a BP subsidiary but which was bought out in 2009 by its management team and a private equity firm, also benefited from technology developed in partnership with the Indian government. This uses an innovative top-lit updraft design; the stove accepts waste biomass, such as crop residues, and provides up to 75 percent fuel savings compared to the 30 to 50 percent that is typical for improved biomass stoves. Their design was also made available through philanthropic donors. Brand Builders are increasingly developing sophisticated in-house design capabilities, even though their competitive strengths often lie further along the value chain in manufacturing and distribution. Sanyo Electric Company, a global electronics company based in Japan, has used a cutting-edge solar technology to develop various pro-poor products targeted to the African market, including solar stations for charging electronics products such as mobile phones and a solar lantern. Netherlands- based Philips, a leader in the global light bulb and LED (light-emitting diode) markets, has built on this advantage to develop a range of BOP products including solar-powered LED torches, the Mini- Uday rechargeable lantern, an improved wood-burning cookstove, and a portable water purification system. Trony, the largest amorphous silicon thin film solar cell manufacturer in China, has built on in-house research capabilities to move down the consumer chain, innovating progressively from large-scale solar cells to solar home systems and on to solar lanterns. HOW COMPANIES ARE SERVING THE MARKET 46 Some PV companies have used their technology platform to extend the product line and reach the BOP. Deng Limited from Ghana started life in 1988 as a commercial engineering company supplying generators and pumps, before moving into solar home systems and later expanding its offering to include solar lanterns, which it assembles locally after procuring parts from the Netherlands. This has helped Deng to grow based on photovoltaics alone; in 2009, Deng had 25 employees (with an additional 50 working indirectly for the company) and a turnover of $1.5 million from sales. On a larger scale, Moser Baer, an Indian-based emerging multinational, leveraged its strengths in manufacturing PV panels and consumer electronics to offer a range of solar lanterns and solar kits that do not require technicians to be installed. ABOVE: Various cookstoves discussed in this report clockwise from top left: Envirofit, First Energy, Katene Kadji, Ugastove, Jiko, and Toyola Source: Envirofit, First Energy, Katene Kadji, Ugastove, Jiko and Toyola. Manufacturing The manufacturing methods used to produce modern energy devices vary greatly in terms of required components and complexity of assembly. Some cookstove technologies are fairly simple, and so lend themselves to production by hand with rudimentary tools. Solar lanterns and home systems are generally more intricate, and need advanced production facilities, especially if quality is to be assured. Ethiopian stove-maker, Tizazu (see box 3.1), is one of many small businesses with in-house manufacturing that can be found across Africa and Asia. The company employs two dozen artisans to craft—entirely by hand—stoves in several sizes using locally available scrap metal and ceramic liners produced in-house. Ghana’s Toyola is perhaps more unusual because it makes its Coalpot stove using a franchise model whereby self-employed artisans in peri-urban and rural communities make certain components of the device that are then combined with elements that the company itself produces. Despite limited automated processes, this profitable firm has been able to sell over 100,000 stoves in Benin, Ghana, Nigeria, and Sierra Leone. 47 CHAPTER 3 Box 3.1: Tizazu makes improved cookstoves in Ethiopia Tizazu is a good example of a local cookstove manufacturer. The undertaken by on-site retailers. If there are any issues with company was started in Ethiopia 15 years ago by the eponymous the stove, customers may return them to the point of sale and, entrepreneur—a former employee of the Ministry of Energy when the next delivery is made, the company replaces them at who had previously worked on an improved cookstove design no cost. and dissemination program. At its initial stages, the program Tizazu has sold an estimated 500,000 units, with annual sales also received support from the German bilateral international of about $20,000 and a 10 to15 percent profit margin. This development agency, GIZ, for awareness-raising efforts. reflects the use of a subsidized warehouse. Tizazu manufactures several models of smartly painted Tizazu stoves are widespread in Ethiopia, but limited exports silver stoves (see figure B.3.1) (adapted to a range of needs, have also been made to Djibouti, Kenya, and Yemen to from traditional njera preparation to coffee ceremonies) at expatriate Ethiopians. The company plans to continue to a warehouse in Addis Ababa and sells them for $5 to $20, expand activities both domestically and in the region, but is depending on the model, at markets across the city and through constrained by a lack of financing (its owner estimates that a handful of local supermarket chains. Some models use wood, $125,000 to $200,000 would be needed for him to import other use charcoal. In addition, a specific honeycomb-styled equipment enabling the construction of a more efficient brick made of compacted charcoal can be purchased for some production facility) and collateral. models at a cost of $0.25. Distribution and marketing is fairly straightforward; each time a truckload of stoves is taken to markets, employees give a demonstration on use to interested customers. When a new stove comes out or a new market is targeted, test users are selected to serve as ambassadors for the product’s efficacy, reliability, and durability. Sales are Materials Improved cookstove Does not include costs of 6.00 3.60 warehouse since this is provided free of charge by the government Annual sales are approximately $, per unit sold 24,000 units. Stove prices vary from $6–$25 and total revenue is thus about $300,000 annually Labor 1.20 Transport 0.60 10% 0.60 Revenue Costs Margin Figure B3.1 Cost breakdown for the smallest Tizazu cookstove Source: Interviews with Tizazu staff. HOW COMPANIES ARE SERVING THE MARKET 48 RIGHT: Local manufacturing of the Tizazu cookstove outside Addis Ababa, Ethiopia (Credit: Pepukaye Bardouille) 49 CHAPTER 3 ABOVE: SMOKE FROM KEROSENE LAMPS CAN CAUSE LUNG DAMAGE IN CONFINED HOMES (CREDIT: IFC) HOW COMPANIES ARE SERVING THE MARKET 50 In some cases, however, the value-added tax and duty quality control as the rationale behind focusing on this part exemptions are applicable only to complete products and are of the value chain. (Figure 3.5 shows the cost structure for a not applied to their components. In that case, the incentive company that provides a high dealer margin as an incentive to for companies to take advantage of cheap labor to set up local stock its solar lanterns.) assembly facilities is reduced, because a locally finished product Most solar home system companies either design and may actually end up being more expensive. manufacture in-house, or procure components for on-site At the manufacturing stage, device companies must pay close assembly, but fundamentally, play across the value chain. India’s attention to product quality assurance. Ensuring production- TataBPSolar, a joint venture between Tata Power Companies line quality is essential, especially when manufacturing is and BP Solar, operates cutting-edge PV manufacturing outsourced, given the risk of market spoilage. BOP customers facilities and is active in a wide range of segments from are particularly sensitive to product quality, and providing megawatt-scale power plants to residential solar home systems acceptable replacement services in the event of breakdown can and devices. Some battery manufacturers, such as Bangladesh’s be expensive. Greenlight has tight control of its production; six Rahimafrooz, have also successfully expanded into solar home staff members are permanently based in China and manage the systems, using their production capabilities to construct other quality of parts and assembly at the factory contracted to make key components. These companies must design products the lights. This unusual focus on the manufacturing part of that meet the needs of local communities, convince them to the value chain is expensive but worth it, since it ultimately purchase these big-ticket items, undertake installation and closes the quality loop down the distribution chain to the regular maintenance, and often provide or facilitate financing retailer and back, protecting the reputation of the product. so that customers can afford them (or find a way to reclaim Fenix has established manufacturing partnerships in China’s the product in the event of default). Thus, they are, by default, Hong Kong/Shenzhen region, where electronics supply chains Integrators. This “full service” approach plays across an often are considered to be among the strongest in the world, thus complex value chain requiring a solid presence on the ground to keeping the cost of production low and quality standards high. furnish the various parts of their service offering both upstream NEST is an unusual example of an SME player that has its own and downstream of the manufacturing element. It also means manufacturing plant, citing the importance of ensuring tight that operating costs are generally high. 30% Solar Lantern 36 11 Manufacturer has sold 150,000 lanterns at $25, putting total revenue at about Materials $3.8 million Distributor margins are high, 25 17 but this is intentional – to ensure $, per unit sold that dealers are incentivized to sell product Labor 3 Overhead 2 Transport 1 8.5% 2 Dealer Dealer Manufacturer Costs Manufacturer Revenue Margin Revenue Margin FIGURE 3.5: Sample cost breakdown of a device made by an Indian solar lantern company Source: Interviews with company staff. 51 CHAPTER 3 Marketing Sales & Distribution Brand Builders often have an advantage in marketing, Distribution is one of the overriding challenges for device although Local Entrepreneurs and International Independents companies attempting to reach low-income markets. sometimes do a better job of leveraging their local knowledge Customers typically live in remote rural areas and do not shop and networks to execute effective grassroots outreach at established retail channels where they would discover new campaigns. As with most consumer categories, low-income technologies. “Typically new technologies start in the urban consumers typically prefer known brands because they are areas and spread out into the rural areas. But in this case you perceived to have better performance and quality. Companies really have a product that is designed for people who are off- with recognized brands—the Brand Builders—therefore aim grid, living in the rural areas, and they may not have a chance to leverage this inherent advantage when offering new products. to see it first in the cities,” explains Ned Tozun, president of solar lantern company d.light. Local distribution chains are Larger players also often enjoy the financial backing of parent fragmented, and cash-poor merchants struggle with working companies to fund eye-catching marketing campaigns. Local capital constraints, low sales volumes compared to other Entrepreneurs and International Independents, on the other products that they could stock, and limited shelf space. Yet hand, have to build their name from scratch. This cost can be other sectors such as beverages, pharmaceuticals, and mobile significant for start-ups, of which only a minority are generally telephony have become very good at distribution in low-income able to mobilize the requisite grant or commercial funding markets. The companies that are able to do this in the energy for their market-building activities. They therefore frequently access market typically do well. capitalize on word-of-mouth and relationships at a local level, but low-cost marketing campaigns can be effective, too. The Brand Builders are leveraging their parent companies’ capital Ghanaian cookstove company Toyola, for example, actively and existing market presence (or strong partnerships) to grow works to turn satisfied early adopters into “evangelists” and distribution, creating a real advantage over other players. Brand ultimately distributors. Evangelists start operating in their Builders with a local footprint already sell other products in- village and then collect and regroup orders from surrounding country (for example, radios, fans, batteries) and can convince villages. Toyola sells about 60 percent of stoves directly to users retailers to stock new energy access items under a name that is easily recognizable. Critically, they can also extend capital or through this channel. Tecnosol in Nicaragua buys solar home offer attractive payment terms to small shop owners. Sanyo, for system units from overseas suppliers, then promotes, sells, and example, is leveraging its long-standing reputation for quality, installs them in rural areas through a similar “early adopter” experience with lower-income products, and deep pockets, model. Tecnosol’s first customers in each area, typically rural to aggressively grow in the Kenyan market. The company’s merchants or shopkeepers, act as local agents who advertise the strategy is based on its partnership with a local distributor, benefits of the service and provide feedback to the company on which sells directly to retailers and to rural sub-distributors. any technical issues. Importantly, it also provides working capital to its distributors Roadshows and other traditional media are popular at the to drive sales deep into rural areas. BOP, and the use of other traditional media can also work Philips is at an early stage of testing a new product, financing, well to promote products. Dutch multinational consumer and distribution approach in Ghana. This is part of an ambitious electrics firm Philips’s “Cape Town to Cairo” 2010 and 2011 plan to develop a commercially sustainable distribution chain road show traveled across 12 countries and was designed to for energy services for the poor, creating additional income for promote the benefits of solar lanterns with consumers and other at least 35,000 people in Sub-Saharan Africa and to provide 10 stakeholders from the public and private sectors. By addressing million people in the region with affordable, appropriate, and both direct consumers and organizations that work with social sustainable energy services by 2015. Philips’s approach includes development issues and the BOP, they increase product visibility collaboration with NGOs, government, its suppliers, and markedly, and product information trickles down to end users complimentary companies like African mobile operator MTN. from multiple sources. SolarNow, a Dutch company that Similarly, Schneider Electric, a French-based multinational, has trains a network of African entrepreneurs to sell and maintain set out to serve 1 million people in India with modern lighting standardized solar home systems, has a network of retailers in services between 2009 and 2011. After one year, it had reached Burkina Faso, Mali, Senegal, Tanzania, and Uganda. It uses a 250,000 people. The key to this rapid growth is that Schneider single brand to help the public identify good-quality products leveraged its own national wholesale and retail network to “where they see the sign,” and runs extensive radio campaigns serve urban areas, but partnered with NGOs and microfinance institutions and the Indian Oil Company’s retail network and designed to make it a trusted name in its target markets. local electricians to serve rural areas. HOW COMPANIES ARE SERVING THE MARKET 52 French-based oil company Total, a relatively new entrant able to sell the product. These have trained hundreds of in the lighting devices space, has made distribution its core microentrepreneurs who typically sell $30 worth of solar competence in this space, using its network of retail outlets lanterns per day, and given the relatively high income that this to resell PV lanterns in Cameroon, Indonesia, and Kenya. provides, are significantly incentivized to expand sales. In the Unlike other multinational counterparts that design their Philippines, solar lantern company SunTransfer is a shareholder own products, Total has selected a handful of existing lighting in Hybrid Solutions, a local distributor which itself has built devices supplied by d.light, Phocos, and Sundaya and signed partnerships with NGOs and microfinance institutions that sales agreements to get the products to market. It focuses have long-standing and extensive networks in villages. on reaching the last mile and leaves design to smaller, more nimble companies. Total purchases large volumes of desirable In several East African counties, Solar Aid is building a products, uses well-branded outlets to sell them, and offers network of franchisees to sell its “Sunny Money” product flexible payment terms and working capital to its partners. through local entrepreneurs. NGOs are involved, but only A central Paris-based purchasing entity deals with all issues to promote the franchise business opportunity to potential related to suppliers and to importing and distributing product. microentrepreneurs. Sunny Money handles the relationship In return, device suppliers gain access to finance and visibility with franchisees directly, giving them a one-week training in these markets under their own brand name. Total is aiming course and access to capital and supply chain support. Solar for 100,000 products sold by early 2012. lantern company ToughStuff has only 20 employees but has sold 200,000 units through third parties. The disadvantage of International Independents often have a harder time mastering this model compared with the integrated distribution approach networks or financing distribution alone, but sometimes partner of larger players is that it reduces market reach and squeezes with social sector players to overcome challenges. Unable to margins, effectively limiting the ability to grow the business. leverage internal or existing partner resources more common to Using a different tactic, U.S.-based Envirofit, which started in larger players, International Independents often sell into third- 2003 as a nonprofit and began producing stoves for sale in East party channels or work with NGOs, community organizations, Africa and India in 2007, has accelerated its expansion using or village entrepreneurs to get their product to market. For donor funds14 to discount cookstoves as an incentive for its instance, d.light uses two approaches to product distribution— distributors to stock their product rather than those of more partnering with Indian NGOs that have established means of expensive competitors. reaching the end user in some areas, and employing a network of local entrepreneurs for others. Similarly, Barefoot Power has Box 3.2 provides an example of how corporate social established subsidiaries in Kenya and Uganda, where it works responsibility (CSR) funds were successfully used to disseminate closely with microfinance institutions to identify entrepreneurs solar PV devices. BOX 3.2: Unilever Tea Kenya Limited UTKL staff are members of a number of officially recognized savings and credit organizations (called Saccos), and are familiar has tapped CSR funding to success- with saving in and taking loans from these groups. The tea fully purchase and disseminate solar company’s management decided to support the Saccos as an PV devices efficient way of providing end-user financing for energy devices, and invested money for the purpose of providing staff loans for Not itself a device supplier, Unilever Tea Kenya Limited (UTKL) the purchase of lanterns. recognized the importance of providing modern energy access to its workers. After realizing that kerosene use among tea pickers To buy a device, a staff member places an order at a central living on unelectrified plantations was resulting in high numbers purchase point offered by UTKL and signs on for an equivalent of respiratory illnesses and burns, UTKL began supporting the loan from his or her Sacco. A portion of the device costs are supply of good-quality solar lanterns to their staff. They worked paid for up front using a bank transfer, cash, or the Kenyan closely with IFC’s Lighting Africa program to define acceptable Mpesa mobile payment system. These orders are collated and quality standards for these devices and develop a consumer sent to a local product distributor. On supplying the goods, the education initiative. In parallel, they designed a distribution and distributor is paid from the UTKL/Sacco account. The staff purchase model that would be financially sustainable over the then receives the products as per their order and begins servicing longer term. the loan. 53 CHAPTER 3 A few players are developing partnerships with other companies across sectors. San Francisco-based design and engineering firm, Fenix International, has adopted such a tie-up for their new ReadySet Solar Kits (see box 3.3). The company demonstrated through pilot studies the potential for increased revenue for MTN, and showed that the operator’s distributors would be keen to sell the product themselves. Fenix developed an exclusive distribution and licensing agreement in Uganda for an MTN cobranded solar kit. MTN imports (handles logistics, clears customs), warehouses, distributes, and assists in servicing devices (dealing with warranty and any product take-backs or replacements). This partnership solves several critical challenges faced by many small device innovators, notably achieving brand recognition in rural areas, scaling product delivery logistics, securing working capital finance for retailers, and providing comprehensive after-sales service in remote communities. The solar lantern companies selling products to Unilever Tea Kenya Limited (see box 3.2) are also leveraging this businesses customer base and distribution channel. Box 3.3: Fenix’s ReadySet, deployed They knew, however, that reaching end users in many parts of their target markets in Africa would be a challenge. in partnership with MTN After initially exploring opportunities to work with beverage, Beginning in 2009, Fenix International spent three years pharmaceutical, and fast-moving consumer goods suppliers, developing a $150 plug-and-play solar charging device that Fenix created a strategic partnership with Google.org, the can power phones, lights, and other appliances. Fenix’s 15 Wp Grameen Foundation, and MTN in Uganda. They felt that ReadySet solar kit comprises a monocrystalline solar panel, mobile operators had the closest alignment with energy access which is small, durable, and high performance. In addition to services, given that the average revenue per user (ARPU) is a key being solar-chargeable, the kit comes with an adaptor that allows measure for commercial viability in the sector, and it depends on it to be plugged into a power outlet where there is electricity users being able to keep their phones charged. Without access available, or into a diesel power generator. Accessories include to charging services, ARPU is unnecessarily limited; indeed, a USB charger for Nokia phones, which have the largest local it is estimated by the GSMA that lack of access to electricity market share; a universal phone battery charger; and an energy reduces an operator’s ARPU by 10 to 14 percent. Fenix research saver lighting kit. The system is modular and can be added to corroborates that number, and finds substantial supplementary over time. In addition, it has open-source charger sockets (a income opportunities for owners of the ReadySets through 12-volt car charger and 5-volt USB) that can be used to power lighting access and phone-charging services. Thus, solving the a range of small appliances. issue of access to charging services is not only a development With its founders coming from Silicon Valley’s high-tech space, goal or an opportunity for energy companies, but also an area Fenix was able to secure manufacturing partnerships in China’s of interest for the mobile phone and technology sector. Hong Kong/Shenzhen region, where electronics supply chains See box 3.4 for how one enterprise in Rwanda developed an are considered to be among the strongest in the world, thus interesting charging model. keeping the cost for production low and quality standards high. LEFT: Fenix’s Readyset in use in Rwanda; RIGHT: the components of the set (Credit: Fenix) HOW COMPANIES ARE SERVING THE MARKET 54 need new image ABOVE: NEW TECHNOLOGIES TEND TO REACH CITIES FIRST, SUCH AS THE ONE THIS MECHANIC LIVES IN; THEY TAKE MUCH LONGER TO REACH RURAL AREAS (CREDIT: IFC) 55 CHAPTER 3 Box 3.4: Nuru Energy and its Rechargeable Solar Lamps Rwandan social enterprise Nuru Energy developed an interesting charging model for its solar lantern business, which allows the consumer to vary his or her spending in line with income. The concept is to sell low-cost lanterns that can be charged using pedal power. Entrepreneurs purchase 50 lanterns ($5 each) and a POWERCycle ($150) from Nuru, with financing from a partner microfinance institution, and begin serving a demarcated area. Each franchise sells lights, normally at a small margin ($6) to local customers, and then receives ongoing revenues by charging customers a fee of $0.25 to charge each lantern. The majority of its customers are subsistence farmers and do not have regular cash incomes; average incomes are reported to be under $1.25 a day. The primary merit of Nuru’s approach is that it mimics the pattern of kerosene expenditures and the income volatility of its customers. So far, most of the company’s operations have focused on Rwanda, where it has been able to reach significant penetration in some rural communities. In the Mayange sector of the Bugesera District in Eastern Province, for instance, Nuru has sold about 1,500 lights. The community has a population of roughly 25,000, or 5,000 households. As of March 2011, it had 70 entrepreneurs and had sold 10,000 lanterns. Nuru is also tapping carbon finance as an additional revenue stream through an agreement that gives Bank of America Merrill Lynch the option to purchase several million certified emission reductions (CERs) over a 10-year period, all of which will be generated in Sub-Saharan Africa. ABOVE: Nuru lights being charged on a POWERCycle operated by an entrepreneur (Credit: Nuru Light) HOW COMPANIES ARE SERVING THE MARKET 56 After-sales Service costs of servicing this down by training its approximately 70 Indian dealers on how to service lanterns, providing them with a After-sales service is particularly important in low-income stock of replacement parts, and only taking products back to the markets. This is due, in part, to the fact that, for the BOP, the factory if they are beyond repair. purchase risk for new or untested technologies is so high and the public understandably wary of what they do not know. In some Post-installation maintenance, or at least offering such service places, it is also relevant, because low-quality products that may agreements, is particularly important for overcoming hesitation have entered the market in the past have had an impact on the on the part of the poor to invest in solar home systems, but can reputation of energy access technologies as a whole. be very costly. Maintenance costs increase with the distance between houses (which can sometimes be several kilometers). Device companies are increasingly focusing on the BOP despite Some service providers complain that multiple visits to customer’s the high relative cost of offering customer service for products homes can result in half the revenues from each system being under $50, and practical or supply-chain difficulties in providing eaten up every year. Nuon-Raps (NuRa) and KwaZulu Energy service to consumers in remote areas. Greenlight Planet’s solar Services, both privately owned concessionaires in South Africa devices, for example, are sold directly by someone living in or that deliver SHS-based electrification in rural parts of the near a village, so that they can easily be returned and repaired KwaZulu Natal, Eastern Cape, Mpumalanga, and Limpopo if something breaks down. Moser Baer and TataBPSolar’s lamps provinces, therefore rely on a government basic energy subsidy, come with a warranty, and the companies provide a consumer channeled through local municipalities, which covers half of hotline for customer complaints, promising to service or replace customers’ monthly rates. Separately, as a result of its particular the product in the event of defect. concession set up almost a decade ago, a capital subsidy from the South African Department of Energy covers up to 80 percent “Formalized” comprehensive after-sales service can be expensive, of capital costs. While typically not as high as that provided to especially in sparsely populated areas. Ethiopia’s Tizazu overcomes concessionaires in South Africa, the implication is that solar this problem by offering customers the option of returning home systems companies providing comprehensive service—as stoves to the point of sale and pledging to replace them when opposed to those selling systems alone—typically require some the next delivery is made, limiting costs to both parties. Tizazu’s degree of subsidy to make these larger household-level energy reputation in the market means that this informal arrangement systems affordable to BOP customers (see figure 3.6). works well. NEST offers a one-year product warranty and keeps Average cost breakdown in $ Government Systems sold at around $300 each at an 375 Subsidy approximate 15,000 systems per year, thus an annual turnover of around $4,500,000 27 209 Company receives a government subsidy of 300 $27 for each system sold at $300 300 $, per unit sold 6JGƂTO UDWUKPGUUOQFGNKUVQGZRTGUUN[UGTXG last-mile customers, reducing margins below 225 the level they would otherwise be if client base were only fully commercial 150 54 75 27 10 4 2 5 5 3.4% 11 0 Sales Inventory Labor Marketing Transport Installation Training Annual Revenue + and sales maintenance collection (other) Revenue Costs Margin FIGURE 3.6: Sample cost breakdown of SHS installed by an Indian company Source: Interviews with company staff. 57 CHAPTER 3 ABOVE: A SUNLABOB TECHNICIAN SERVICING SOLAR HOME SYSTEM EQUIPMENT, THE SUNLABOB YELLOW BOX (CREDIT: SUNLABOB) HOW COMPANIES ARE SERVING THE MARKET 58 Consumer Financing Despite the savings they provide, modern energy devices—in particular, solar home systems—can be too expensive for low-income consumers to buy up front, requiring companies to offer credit and staggered payment solutions. With product costs that can reach $300 to $400, solar home systems companies need to offer financing to their customers. To increase affordability, they typically provide a combination of credit to cover a deposit and also offer the option of making additional monthly payments to cover the balance. TataBPSolar, for example, has “replaced” the up-front cost of its solar home system units entirely in favor of monthly payments over five years, financed through a mixture of the company’s own balance sheet, a $60 subsidy per connection from the Government of India, and carbon credits. The company had installed 100,000 systems by the end of 2010, and added another 100,000 in 2011. Grameen Shakti has also developed an in-house financing solution for solar home systems, which is independent of its mother company, Grameen Bank. Customers can either pay $374 in cash for a unit, or make a down payment of $58 and pay an $11 monthly installment for three years. This implies a loan from Grameen Shakti to the customer at an interest rate of 15 percent. A more common and possibly less burdensome approach is to partner with microfinance institutions and rural banks that already provide financing in target markets. SELCO relies on such tie-ups, working with about 40 rural banks that offer micro-loans to its customers in India. If a customer is unable to repay their loan, SELCO can reclaim the device and sell it on the second-hand market, returning the revenues to the bank. While less common for devices, there are cases of partnering with microfinance institutions. Hybrid Solutions, a Filipino distributor of solar lanterns, has developed an interesting partnership with CARD MRI, a leading microfinance institution that sells solar lanterns to its members bundled with a loan for the purchase, creating an additional distribution channel for the company and revenue for the microfinance institution. Despite lower up-front product costs, cookstove companies have also experimented with consumer financing to increase reach among the poorest. Ugastove in Uganda makes its $7 improved wood and charcoal cookstoves more accessible by allowing flexible repayment terms that correspond to the cash saved on charcoal. Since 2006, Ugastove has sold around 80,000 devices and is expanding into more remote parts of Uganda and neighboring countries. Toyola offers customers the option to buy on credit and to pay back the loan over two months using the money saved on charcoal, with many stashing their savings in a “Toyola Money Box.” Annual saving on charcoal of around $27 is significant for a household with an annual cash income of around $800 a year, and means that the cost of buying a Coalpot is recovered within three or four months, with the company claiming a repayment rate of 99 percent. The funds it needs for such a credit plan come from concessional loans and are expected to be met by carbon finance in the future. 59 CHAPTER 3 ABOVE: DISTRIBUTION WILL MAKE OR BREAK THE DEVICES SECTOR, PARTICULARLY AS PRODUCTS INCREASINGLY BECOME COMMODITIZED (CREDIT: PEPUKAYE BARDOUILLE) HOW COMPANIES ARE SERVING THE MARKET 60 Devices: Key Business Model Success Factors Affordability, distribution, and consumer confidence are the key success factors for device companies. Enterprises in the household lighting and cooking markets clearly have different preconditions for commercial success, depending on technology and positioning along the value chain. The three factors that stand out for the household-level devices and systems subsector are: • Making products affordable to cash-constrained customers and, in particular, providing end- user financing for solar home systems • Building, tapping, and financing distribution networks • Strengthening consumer confidence in energy devices (see figure 3.7). Making products Strengthening Building, tapping, Financing the up- affordable to cash- consumer and financing front cost for end constrained confidence in distribution users, either customers and, in energy devices networks through particular, providing corporate funds end-user financing or finance for solar home partners systems Design / Sales & Billing / Consumer After Fuel R&D Production Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance FIGURE 3.7: Key success factors in the devices business model Source: IFC analysis. Make products affordable process are also important for capital-intensive solar devices and favor a high degree of central manufacturing. Outsourcing of It may seem obvious, but companies attempting to penetrate the the manufacturing portion of the value chain to more efficient, BOP market must go to extremes to strip out costs and make specialized companies is therefore frequently the most cost- product prices as low as possible. Design innovation, supply effective option. chain efficiencies, and distribution are all areas for cost reduction, although the implications are quite different for capital-intensive For cookstove companies, supply chain efficiencies focus solar devices and systems on the one hand, and more labor- around labor. Local Entrepreneurs such as Tizazu and Toyola, intensive cookstoves on the other hand. for example, have removed costs by keeping design very simple and leveraging local artisans, often reducing their cost bases Design innovation coupled with falling component prices has below those of International Independents and Brand Builders. already helped cut costs of solar devices, and further declines of Tizazu also benefits from a subsidized building that serves 40 percent are expected by 2015, largely driven by lower solar PV, as a storage center for raw material, a production line, and an battery, and LED prices.15 But scale economies in the production end-product warehouse. Toyola achieves efficiency and quality 61 CHAPTER 3 control by outsourcing all but the key ceramic liner portion of Grameen Shakti and other solar home systems entrepreneurs its stoves, and by encouraging the artisans who form its supply in Bangladesh is closely linked to government-owned IDCOL, chain to specialize in specific components. Some International which provides concessional monies for end-user financing. Independents and Brand Builders are considering shifting to Established in 1997, IDCOL is mandated to promote private local fabrication to reduce transportation and import tariffs. sector financing in the infrastructure and renewable energy The international transport component alone, of Envirofit sectors, and is currently implementing solar home system, stoves manufactured in China and sold in India, for example, domestic biogas, solar mini-grids and pumps, biomass, and is estimated at 20 percent of total costs, driving the company’s biogas power projects. move to localize production in India. In addition to providing concessional loans for end-user finance, Distribution is another major cost driver in the supply chain. IDCOL has played a vital role in building the solar home The examples above have demonstrated the choice is between system market in Bangladesh, initially as a main component of proprietary distribution channels, which add fi xed costs but may the Rural Electrification and Renewable Energy Development bring competitive advantage, or third-party distribution, which Project of the World Bank, by establishing solar home system can add flexibility but also introduces a middleman and erodes product certification supported using a subsidy incentive plan. margins. Either choice requires a diligent focus on controlling The Government of Bangladesh finances IDCOL at 3 percent costs. and acts as a conduit for financing by the Asian Development Bank, GIZ, Kf W, the Islamic Development Bank, the Global Another tactic for maximizing affordability is to adopt a payment Environment Facility, and the World Bank. For a solar home profile that mirrors the traditional spending profile of customers system bought with a three-year credit with a 15 percent down who would otherwise use kerosene for lighting or charcoal for payment, IDCOL lends to the distributor 80 percent of the cooking, as discussed below. As described above, the subscription amount borrowed at 6 to 8 percent over 7 to 10 years, with a or fee-for-service model is a good solution for solar home systems, one-to-two-year grace period. Using this capital, firms that and allows customers to make regular payment for use rather are approved as suppliers of products with IDCOL’s technical than covering the entire cost at once. But this can be applied to specifications on-lend to customers at an annual interest rate devices, too, as has been done by Nuru and Sunlabob. equivalent to 15 percent. End-user financing can be critical for ensuring affordability but introduces complications. We saw, above, how end-user financing is also relevant, particularly for making solar home systems Building, tapping, and financing distribution affordable. This is also discussed in a number of publications networks including Selling Solar.16 Firms that operate in regions such Fundamentally, distribution makes or breaks the devices sector, as South Asia, where strong microfinance organizations are and this is only likely to become more important as all devices prevalent, may therefore have an advantage here. Certainly, move toward product commoditization. Kerosene for lanterns, Bangladesh and India, where microfinance is most entrenched, the latest mobile phone models, disposable batteries, soap have produced the most successful solar home system businesses. products, and bottles of Coca-Cola have all managed to reach In-house financing, however, offers management full oversight of the most remote customers across the developing world. To the business but requires deep pockets and can create balance sheet date, since these are early-stage businesses, many solar lantern, complications for most companies. This is therefore probably solar home system, and cookstove players are still struggling to best suited to those larger Brand Builders (in this case, typically secure last-mile distribution. This report’s assessment is that, local conglomerates as opposed to multinational corporations) against a backdrop of potential product commoditization, the that have the necessary skills to manage loan arrangements and strategic weight of this industry is shifting from the design and payment tracking, on top of the already complex process of manufacturing gurus to the distribution “gatekeepers.” system delivery and maintenance in remote communities. Box 3.5 explains how Greenlight Planet is building its own Many solar home systems companies would have struggled distribution network. to succeed without the availability of soft loans from either international or local development institutions, which can be on-lent at a reasonable mark-up to customers. The success of HOW COMPANIES ARE SERVING THE MARKET 62 Box 3.5: Greenlight Planet: Building its own distribution network Greenlight Planet is a pioneer in the market for photovoltaic lighting for the poor, and its story highlights the central challenges for device companies launching new technology in hard-to-reach villages: distribution and customer awareness. The company was started by Mayank Sekhsaria, Anish Thakkar, and Patrick Walsh in 2005 while they were students at the University of Illinois in the United States. At that time, there was really no market for solar lanterns—only a need. The trio’s response was to create a for-profit company. It started selling its Sun King solar lantern in mid-2008, first in India and now in 10 African countries. Six years later, it has reached breakeven. Greenlight experimented unsuccessfully for a year and a half with traditional distribution chains into rural India and had to navigate at least four links in the chain from master distributor down to a village retailer. Each link takes 8 to 15 percent margin and requires credit. Even with 50 percent added to the manufactured cost, and sufficient credit extended to get it to the retailer, the product would sit in a store without anyone knowing of its existence. The market is still so new that even today consumer misconceptions about solar lanterns abound. Some believe that the product will break prematurely or, without knowing the actual price, assume that it must be too expensive. Established consumer product companies overcome these problems with road shows that travel from village to village promoting new products—an expensive and not particularly effective way to get the job done, especially for a big-ticket item like this. Greenlight decided to sell its products directly by recruiting respected members of the community, like a teacher or subsistence farmer, to become a part-time salesman for the company. These “saathis” spend several hours a day visiting people in their area of about 2,000 homes demonstrating and selling the product. Saathis can expect to about double the $50 to $80 per month that they earn in their “day job” with the extra income from selling lamps. Product demonstrations, together with the fact that saathis are known by and accountable to their neighbors, reassure customers about the product and increase uptake. Greenlight now has 650 saathis selling about six to eight units a month each, saturating 70 percent of their villages within six months, often with repeat purchases. The saathis report that at that point, they move on to other villages. Knockoffs have appeared in small numbers without much sales success, but they do damage the reputation of solar lamps in general, resulting in market spoilage. For now, however, Greenlight is not concerned about the threat of competition; it believes that its distribution system is unique and hard to replicate, making this the main defense against competition. The downside of building a distribution channel from scratch is that it limits a company’s ability to quickly scale. While Greenlight has ambitious expansion plans, it still sells only 8,000 units per month. When it expanded into Africa from India, it opted to use third-party distributors rather than recreating the saathi system, partly due to the scale issue, and partly due to the challenge of managing different national regulatory systems and cultural norms. 63 CHAPTER 3 Strengthening consumer confidence in energy devices Low-income customers are understandably cautious when asked to spend a large proportion of their small and often sporadic income on unfamiliar technology, and companies need to work hard to build consumer confidence. Perhaps counterintuitively, many customers will in fact prefer existing solutions to more economical modern alternatives (see figure 3.8), particularly when cheap but unreliable versions have already entered the market. If the device breaks down before it breaks even, the customer will be financially worse off, deterring future customers and leading to market spoilage. Paraffin lamp with a glass cover 25% Light bulb in socket or a lamp connected to a car battery 18% Solar-powered lantern 15% Battery-powered stand-up lantern 12% Pressure lamp 9% Simple paraffin lamp with wick and no cover 5% Candles 5% Flashlight 5% FIGURE 3.8: What is your preferred type of light, excluding electric light bulbs powered from the grid?, Ethiopia Sources: Lighting Africa, IFC. In the words of one developing markets consumer expert: “The issue is the life cycle of the products. When you launch a soap or a detergent, people will know after one week if the product is good and their neighbors will hear about it. It takes more than a year for customers to see by themselves that a solar lantern is a worthwhile investment [given the payback period].” 17 Consumer awareness is critical but costly, and can usefully be supported by donors. The cost of building public awareness can be the difference between a company making a profit or posting a loss. As figure 3.9 shows, the marketing expenditure of one improved cookstove company in India—of which 85 percent is attributed to building consumer awareness and only 15 percent to brand association—is 2 percent of total company costs. When R&D costs are added, it incurs significant costs. Rather than breaking even or making a small profit, this company is just breaking even on this particular product, and cross-subsidizes the product with revenues from fuel sales to households and higher-end product sales to restaurants. HOW COMPANIES ARE SERVING THE MARKET 64 Operational breakeven Marketing expenditure breakdown RTQƂVUDCUGFQPHWGNUCNGUETQUU 50 subsidization with commercial stove sales Awareness Raising Training of 46 1.0 26.5 distributors Consumer 85% 15% Brand association 40 $, per stove sold information 30 20 3.2 2.6 6.0 10 0.8 1.3 10% 4.6 0 Stove sales R & D Manufacturing Import Marketing Distribution After-sales Labor (in China) duties and service (12%) awareness (6-month raising warranty) Revenue Costs Margin FIGURE 3.9: Sample cost breakdown of a device made by an Indian cookstoves company Source: Figures provided by company staff. Four marketing approaches effectively build brands, create awareness, and reassure customers about product quality and reliability. They are: • Word-of-mouth: As the Tizazu and Toyola examples have demonstrated, this is often the best way to sell goods that require people to “experience” the benefits in order to convince them to make the purchase, especially when the audience may be illiterate or off the regular media grid. • Leveraging publicly funded campaigns: The Lighting Africa program’s success in Kenya shows that these campaigns can be effective in creating legitimacy and trust. • Leveraging existing consumer brands: Philips is using its brand to sell its solar products. BP cobranded First Energy’s products when it owned the company. • Providing product guarantees: Warranty and after-sales services can be vital to successfully building a market. However, it is critical that companies be able to honor these through their retailers. 65 CHAPTER 3 ABOVE: AN INDIAN FATHER AND DAUGHTER WITH A GREENLIGHT PLANET SUN KING LAMP (CREDIT: GREENLIGHT PLANET) HOW COMPANIES ARE SERVING THE MARKET 66 Devices: Key Success Factors in the Ecosystem Environment Even with the right business models in place, device companies need to be supported with an enabling environment. The most important ecosystem conditions are: • Building technology awareness in the market • Enhancing product quality assurance and creating quality standards • Training and supporting local entrepreneurs and industry contributors • Ensuring that tax and duty regimes do not discriminate against specific energy access technologies • Financing company growth and operations from an early stage • Supporting access to carbon credits (see figure 3.10). Creating quality Building standards technology awareness in the market Design / Sales & Billing / Consumer After Fuel R&D Production Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance Ensuring that tax Training and Financing Financing the and duty regimes supporting local company growth carbon credit do not entrepreneurs and operations application discriminate and industry from an early process against specific contributors stage energy-access technologies FIGURE 3.10: Key success factors in the devices ecosystem environment Source: IFC analysis. Building technology awareness in the market In general, companies—or in some cases sector organizations—invest significantly in promoting market awareness of new technologies and building consumer trust. Almost without exception, businesses that seek to bring modern and affordable energy solutions to the unserved poor are operating in frontier territory. They are creating new markets. Beyond the branding of specific products (discussed in the previous section), a broader effort is therefore required to promote market awareness and confidence in new technology, especially where early poor-quality products have damaged consumer trust. Where there is high awareness of solar technology, as in Kenya, product sales are also higher. But market awareness of energy access solutions in many developing countries is generally extremely low. For instance, Cambodian device firm Kamworks reports that only 10 percent of its target market knows of alternatives to kerosene lighting. 67 CHAPTER 3 Advertising campaigns, standard-setting regimes, and training In addition to supporting consumer awareness, IFC’s Lighting of distributors are critical for market development initiatives. Africa program has played a significant role in establishing Efforts intending to build technology awareness and assure initial quality and performance standards and certifications to product quality must ideally include these three central elements: help consumers make informed choices, with very good results. public advertising campaigns, credible labeling and certification One component of the program is the development of a locally standards that can be understood by consumers and bulk buyers, appropriate, easily recognizable quality seal for solar lanterns in and training of entrepreneurs and distributors on the safe use Kenya. The program worked with test laboratories in China, of new technologies—particularly where installation and Germany, and the United States, and recently in Kenya, to maintenance is required. establish low-cost testing services for lighting products. The Donors have extensive experience in consumer awareness- tests allow manufacturers, distributors, NGOs, and other raising tactics across sectors such as education and health care, players to accurately measure a product’s performance. In which should be leveraged for energy services. This is already Kenya, a mobile telephone SMS (short message service) has happening in some places. The Global Environment Facility been launched, whereby a blank text message sent to a local and the United Nations Development Programme have worked number generates a real-time update on approved solar lantern to promote understanding of solar options in Tanzania by products. This provides information to customers while they are installing solar systems in schools or hospitals.18 In Ethiopia, in a shop and greatly reduces the need for separate advertising. the Ministry of Agriculture, together with Germany’s GIZ, the The biannual Lighting Africa Business Conference and Trade Shell Foundation, and the Netherlands Directorate-General of Fair is seen as the industry reference event, facilitating business Development Cooperation, were instrumental in promoting partnerships. Over 600 participants from 50 countries attended clean cooking options. They focused specifically on the open- the 2010 conference. To date, companies that have passed source Mirt Stove, but the impact has been much wider, with Lighting Africa quality tests sold 175,000 products, translating local companies benefiting from improved awareness. So, while into more than 850,000 people with access to modern lighting. they are socially oriented in their objectives, public awareness It is now expanding activities into Ethiopia, Mali, Senegal, and efforts can also help establish conditions for commercial market Tanzania. Initiatives are under way to develop quality standards entry. for stoves through the Global Alliance for Clean Cookstoves. More than awareness, this illustrates that donors and Enhancing product quality assurance and governments can add significant value by developing standards creating quality standards that spur confidence in new technologies. Quality standards are important for new and emerging technologies because they help consumers identify the right Training and supporting local entrepreneurs products to meet their needs, and they foster trust. If well- developed quality standards provide valuable information to Governments and development partners have helped customers and create a level playing field in which companies companies by providing training and support to energy compete on the basis of not only price but also performance, access entrepreneurs. A thriving device sector requires strong ultimately, cost-effective but also ethical competitors will enjoy capabilities along the value chain, including local entrepreneurs an advantage, not because their products have been given an who understand the opportunity and have the capacity to seize unfair advantage, but because their products have been given it. In many places, public sector players and other development the opportunity to demonstrate their value. At the same time, partners are involved in training artisans, retailers, and such standards need to be sufficiently practical to encourage, technicians, particularly those entrepreneurs involved in last- rather than hamper, innovation and competition. mile distribution. In the cookstove industry, the Grassroots Business Fund provided enterprise development support to “If the device breaks down Servals in India, while in Ghana, Enterprise Works trained tinsmiths, ceramists, and retailers, and a developer that has before it breaks even, the supported Toyola. Lack of trained personnel has also been a barrier to the scale-up of solar home systems. customer will be financially worse off, deterring future customers and leading to market spoilage.” HOW COMPANIES ARE SERVING THE MARKET 68 Also in Ghana, a local firm, Deng, established a training center in conjunction with the Kwame Nkrumah University of Science and Technology, developing accredited courses for technicians financed with grant funding (this center has recently been spun off into a separate entity). Ultimately, developing a cadre of trained professionals has served its own business. “Training and supporting entrepreneurs does not simply build improved products, but can help to build an industry.” It is crucial that governments, donors, NGOs, and other social entities play a role in market development and transformation activities. The goal of the initiatives described above is not to build improved cookstoves, solar lanterns, or solar home systems, but to build an industry. Early market development efforts such as technology awareness campaigns have high costs and little return on investment for companies themselves, because fast-follower competitors can easily reap the benefits. This is a gap that can usefully be filled by the public sector and development partners. Ensuring that tax and duty regimes do not discriminate against specific energy access technologies Inconsistent government duties discriminate against one technology over another, and can distort markets while limiting the potential for disruptive technologies to enter and reach scale. Governments sometimes impose heavy import duties on solar lanterns and home systems, improved cookstoves, or their key components, which increase sales prices and limit market penetration. This is surprising, given that grid extension often benefits from subsidies, and that tax revenue contribution from improved off-grid energy access devices is likely to be low in the bigger scheme of things. A recent Lighting Africa survey19 in a dozen West African locations where solar lighting products are not prevalent showed that import duties range from 5 to 30 percent, and additional taxes such as the value-added tax can be up to 19 percent. This led to a total tax and duty burden of up to half of end-user cost in some countries. In Kenya, Envirofit pays $8 in tariffs for a $15 stove. In Malawi, solar panels are subject to a 50 percent duty. In India, import duties and taxes add about 11 percent to the cost of d.light’s solar lanterns and 12 percent to the cost of First Energy’s improved cookstoves. In Cambodia, there is a 35 percent import tax on finished solar lighting products. The result, understandably, is slower uptake of energy access products. It is important that tax exemptions be consistent across technologies and that import processes be streamlined. Interestingly, when tax exemptions exist, they might, for example, apply only to PV panels and not to other complementary solar home system components, or to lighting devices or stoves. And even where countries like Ethiopia, Kenya, and Tanzania have eliminated or substantially lowered such taxes, importers still complain of lengthy procedures at the port of entry that stem from a lack of understanding of solar products among customs agents, corruption, inconsistent tax treatment of goods, or all these factors. 69 CHAPTER 3 ABOVE: ENVIROFIT IS TARGETING $15 TO $20 PER STOVE FROM CARBON CREDITS IN ELIGIBLE AREAS TO HELP BRING THE RETAIL PRICE OF ITS STOVES TO A COMMERCIALLY VIABLE LEVEL (CREDIT: ENVIROFIT) HOW COMPANIES ARE SERVING THE MARKET 70 Financing company growth and operations from an early stage Energy access entrepreneurs frequently struggle to finance company growth and operations from an early stage. Larger Brand Builders may benefit from the support of their mother companies to finance new business ventures. But smaller players have an inherent disadvantage, and combine the difficulties of being a start-up in an emerging industry with the structural difficulties of selling durables to the poor. Common financing needs and challenges of these small businesses can be illustrated along the stages of a stylized company life cycle (see figure 3.11). Business Model Development Proof of Concept Maturity Companies often have Companies have a high Companies untested products and cash burn and little to are now in Profitability limited management no revenues. the growth experience. They also stage. sometimes face high R&D and other development costs. Break- even Technology/business model advancement Early stage companies require grant The need at this stage is Maturing companies need and angel financing to stay afloat while for venture capital with long-term, local-currency- they work toward proof of concept. management assistance denominated debt to grow. to establish operations. Working capital and trade finance are also required. FIGURE 3.11: Financing needs and obstacles early in the company life cycle Source: IFC analysis. Early-stage funds are difficult to secure, especially for companies originating in the developing world. During the R&D phase, entrepreneurs typically require grants or angel financing and incubation support to turn a good idea into a solid concept and to prove technical feasibility. Even if an idea looks good on paper, this stage is clearly risky, and finance can be hard to secure. Many of the fastest-growing International Independents have enjoyed early-stage financing from social and double bottom line investors, particularly in the lighting sector, where there has been some high-profile venture capital interest in recent years. For instance, in 1997, SELCO received a $128,000 start-up loan from USAID (the U.S. Agency for International Development). d.light design secured $6 million in Series A financing from a group of venture capitalists including the Acumen Fund, Draper Fisher Jurveston, Garage Technology, Gray Matters Capital, and Nexus Venture Partners. These investors have been involved in a second round of $5.5 million in Series B financing, which also includes a new social investor, Omidyar Network, now the largest investor in d.light. Barefoot Power, too, has had support from investors willing to take a higher risk, securing a €1 million grant (about $1.4 million) in 2010 from the European Union. Fenix International has raised several million dollars from New York- and Silicon Valley-based angel investors. But, in general, early-stage funds remain difficult to secure, especially for companies originating in the developing world that have low visibility to international impact investors and a limited pool of local venture capitalists or a limited tradition of philanthropy in the social enterprise space. 71 CHAPTER 3 Patient capital and other forms of equity are critical as companies seek to prove commercial viability. After the development phase, start-ups need to prove commercial viability, but revenue generation and operational breakeven can take time. Cash-burn is often high while revenues are low. Entrepreneurs are rarely able to borrow from banks, and management teams need to stay motivated, and fed. This is where patient capital, such as that provided to Envirofit by the Shell Foundation and other partners—collectively helping the business to transition to a for-profit venture and sell some 300,000 stoves—can be of great help.20 As companies move into the growth stage, long-term investment in the form of both debt and equity is important. As operations enter steadier ground, entrepreneurs begin to focus on scale, which requires long-term investment. Both equity and debt are important, with debt ideally denominated in local currency to protect against exchange rate fluctuations for those companies whose costs and revenues are primarily in local currencies. But even after many years of profitable operation, many local SMEs find it difficult to borrow money. The number one constraint to growth for Tizazu’s stove business in Ethiopia, for example, is an inability to borrow money to buy equipment and automate its production line. Mr. Tizazu requires about $125,000, but does not have sufficient collateral to secure capital from local banks, which are asking for a 200 percent guarantee. He does not own a warehouse and his inventory of cookstoves and supplies would neither suffice nor count toward the requirement. Meanwhile, these financing needs are well below the threshold for most foreign investors, including development finance institutions looking for a larger financial play. Mr. D. T. Barki of NEST, whose lenders require 150 percent collateral on loans, has been able to secure bank financing to expand his operations because his manufacturing facility—built with his own equity—serves as an asset. “Early-stage funds are difficult to secure, especially for companies originating in the developing world that have low visibility to international impact investors and a limited pool of local venture capitalists or philanthropists.” Besides the longer-term issue of corporate financing, the day-to-day challenge of working capital is critical for lighting and cookstove companies and has led to tangible bottlenecks along the value chain. Some companies have managed to secure short-term working capital financing. The Grassroots Business Fund, via Oikocredit, is providing Barefoot with a $1 million line of credit tied to international purchase orders to meet its working capital needs. In the case of Toyola, its first $70,000 loan allowed the company to buy a truck, and provided enough working capital to help unlock a good part of its supply chain by supporting suppliers and distributors with favorable payment terms. Distributor finance is especially necessary for solar home system companies. To meet the cash flow needs of its distributors, Ghanaian supplier Deng provides three months’ credit on components to its network of rural dealers, some of whom use this to allow reliable customers to pay two-thirds up front and the remaining third within three months—the credit term they have from Deng. In the case of commercial solar PV systems, all costs are paid for at installation. These examples show how a greater supply of working capital credit for device companies could help unlock potentially crippling bottlenecks along the value chain, catalyzing their growth. We estimate that the annual working capital needs of rapidly growing Independents such as d.light, Barefoot Power, and Greenlight Planet is about $3 million to $5 million each. But accessing even this relatively small amount of funds is not trivial, since working capital is not readily available from most investors interested in the space. HOW COMPANIES ARE SERVING THE MARKET 72 Supporting access to carbon credits is worth $1526 on the carbon market, a single stove, lasting five years, could in theory generate as much as $75 in carbon Carbon finance is proving to be an important alternative payments. In practice, because stoves generally break before five revenue stream for some cookstove manufacturers, which some years and because of other adjustments in the methodology, $20 believe could potentially transform the sector. The opportunity to $30 is a more likely achievable figure. Given that the cost of a for companies to subsidize the end price of cookstoves with new cookstove is between about $7 and $25, a company able to large carbon revenues is just emerging. In 2007,21 it became qualify for and leverage carbon credits could in theory use them feasible for the first time to earn and sell carbon credits from to cover most or all of the cost of a stove. This development has the reduction in greenhouse gas emissions that results when the potential to disrupt the cookstove market and significantly people switch to improved cookstoves. The Gold Standard increase market penetration. Also, for lanterns and solar Cooking Stove Methodology V.01 followed in June 2008. The home systems, recent developments in the programmatic Gold Standard is a form of accreditation allowing emissions Clean Development Mechanism (CDM)27 might start to reductions from improved cookstoves to be sold to other shift the cost-benefit balance in favor of carbon finance. For buyers.22 example, AMS-III.AR methodology (for calculating emissions reductions achieved by substituting fossil-fuel-based lighting Several cookstove suppliers are starting to leverage carbon credits with LED lighting systems) is now harmonized with Lighting to allow for price reductions that increase market penetration. Africa quality assurance specifications, opening carbon finance In 2009, Toyola registered the second-ever Gold Standard stove project worldwide23 with the assistance of E+Carbon, selling for compliant products. the first tranche of carbon credits to Goldman Sachs in 2010. In 2009/10, Toyola derived 28 percent of its $550,000 income from carbon finance. Future revenues from carbon credits “Patient capital is, of course, key are also expected to reduce the price of the Toyola cookstove, for device companies to grow, enabling deeper market penetration. Players like Envirofit are targeting $15 to $20 per stove from carbon credits in eligible but working capital is also critical; areas to help bring the retail price of its stoves to a commercially viable level. A number of cookstove projects in Ghana, Kenya,24 without this, even low-cost products Madagascar, Mali, Nigeria, and Uganda have also registered to receive carbon payments.25 cannot get to small, last-mile Carbon credits have the potential to disrupt the cookstove distributors and retailers.” market and drive market penetration much deeper than previously seen. An improved cookstove typically uses 35 percent to 50 percent less fuel than a traditional cooking solution, reducing emissions by up to 1 ton of carbon dioxide per year. Assuming that a reduction of 1 ton of carbon dioxide 73 CHAPTER 3 While there is potential for carbon finance to catalyze the device space, there are four main constraints: • Up-front cost: Registering a cookstove company for carbon credits can be expensive, typi- cally costing $120,000 to $200,000, which is prohibitively high for smaller companies. One developer estimates that only companies with sales of 12,000 units per year can reduce the price through carbon payments.28 • Time lag in receiving carbon revenues: Carbon payments are only generated after a crediting period and issuance of the first emission certificates, which are then sold on the carbon mar- ket. It can typically take two years for revenues to flow. When they do come, revenues are paid annually. The need to fund fairly high outlays associated with strict monitoring requirements during the initial registration process means that most cookstove companies must access some form of external finance to start their carbon payment programs. • Uncertain prices for carbon credits make it difficult to access external financing: There is often uncertainty over whether a project will be able to access carbon finance. Even if it does, the price at which credits will be sold is uncertain. • Often complex and expensive registration process. To benefit from the potential of carbon payments, cookstove and other device companies generally need to access finance that spreads the cost of registration and covers the cash-flow gap between subsidies and carbon payments. HOW COMPANIES ARE SERVING THE MARKET 74 ABOVE: BATDEONG ELECTRICITY COMPANY IN CAMBODIA DISTRIBUTES ELECTRICITY ALONG CONVENTIONAL INFRASTRUCTURE TO COMMUNITIES OFF THE CAMBODIAN NATIONAL GRID (CREDIT: BATDEONG) 75 CHAPTER 3 Community-level Electrification through Mini-Utilities Hundreds of nonutility operators in developing countries are running decentralized village power systems, or mini-grids, that provide electricity to poor areas unserved by the central network. Mini-grids use a range of technologies, mainly simple diesel generators or hydro systems, but also biomass, PV, and sometimes wind or hybrids (see figure 3.12). They vary enormously in size, too. These businesses, which we call “mini-utilities” given that they operate as electricity companies, just on a smaller scale, may have as few as 10 customers or serve several thousand connections, but generally use systems of 30 kW to 500 kW (compared to the 500 MW29 typical centralized plants). Many mini-utilities run systems that have no connection to a central grid. But in some cases they are also grid connected (often with varying reliability), which allows them to draw power from the system and feed back any excess power generated. What is important is that they operate a system that can stand alone and serve a small community. Depending on the business model, they serve commercial, institutional, and household demand, distributing electricity directly to end users.30 Biomass Wind Micro-hydro Solar PV Diesel s Generate power s Convert the s Harness force or s Use solar cells to s Use diesel or Description from gasified kinetic energy of energy from convert sunlight other liquid fuels feedstock wind into electric running water to into electricity (e.g., biodiesel) (agricultural and energy generate power s Can be mounted s Combination of forestry residues, s Require wind s Typically on rooftops as diesel engine and energy crops, speeds of 4–5m/s run-of-river but solar home electrical household and to be viable some-times with systems or as generator industrial waste) a reservoir larger arrays (alternator) s Generally s Low operating s Well-understood s Suitable for s Simple to operate considered costs technology almost any sunny and maintain Pros mature/ s Low operating location s Widely available well-understood costs s Low operating fuel and spare technology costs parts s Raw material s Still considered s Systems have s Still considered s Not a renewable supply chains can "technologies in broad range of "technologies in energy resource be complex learning" capital costs learning" s Linked to the s Biomass supply s Although fairly linked to nature s Although fairly price of oil so Cons may be seasonal, standard systems, of project site standard systems, costs can be and fluctuations technology has s For run-of-river technology has highly volatile affect operating relatively high sites, power relatively high s Fuel supply costs capital costs generation can capital costs logistics can add s Power generation fluctuate, s Power generation to costs in remote can be depending on can be areas intermittent precipitation intermittent FIGURE 3.12 Overview of mini-grid technologies Source: IFC analysis. HOW COMPANIES ARE SERVING THE MARKET 76 Decentralized power systems usually offer a significant jump up the energy ladder31 from household-level devices and solar home systems because they allow AC (alternating current) appliances to operate. Mini-utilities do not always result in customers accessing comprehensive electricity services—in many cases they are initially only used for lighting because end users simply cannot afford more than this. Sometimes they provide unpredictable power, for instance, when there are diesel fuel shortages, when rivers run dry during parts of the year in hydro systems, or when poor maintenance results in outages. In addition, mini-utilities generally do not address thermal energy needs such as cooking or heating. However, what is important is that they do provide the option of more than just lighting, affording a much broader set of energy services, including the “productive” use of energy beyond the home, such as for running machinery, manufacturing, or service activities. This, in turn, can support income generation and economic development. Mini-utility business models can be complex, requiring site planning and installation, institutional setup and governance, financing and technical services, and maintenance. Some mini-grids are fairly straightforward, comprising a small generator and some wires, and run next to the demand center. Others, particularly those based on renewable energy, need significant resource measurement and site planning before they can be (sensibly) built. Many need fuel supply chains, whether for diesel or biomass. Mini-grids also clearly need much more investment than household- level solutions (devices and solar home systems); they can cost from tens of thousands of dollars for a small diesel/biomass plant to the low hundreds of thousands for a hydro system, excluding the cost of power distribution infrastructure and meters. This needs to be recouped over a longer time frame and, ideally, from different customer categories. But the nature of the technology also means that a good operator must effectively source and manage the fuel used, or in the case of renewable energy, fully understand the resource potential, to generate power cost-effectively. Given that they are suppliers of electricity, mini-utilities are also often regulated, much like their larger counterparts. Mini-utilities have sprung up around the developing world, from Cambodia and India to Bolivia, Brazil, Colombia, and Peru, across the Philippines, and in many parts of Mali and Nigeria, selling power to a mix of well-off and poorer customers. In Cambodia, for example, 42 percent of electrified households outside the capital city of Phnom Penh are served by decentralized mini- grid systems. In Bangladesh, India, and the Philippines, entrepreneurs are supplying power in a similar manner. In Nigeria, it is not uncommon for operators to efficiently serve sizable urban pockets that would otherwise resort to running expensive individual diesel generators as a backup to unreliable grid supply. In Colombia and Mali, privately owned and operated systems are central to the governments’ electrification strategy for rural and remote areas, and in Rwanda, one entrepreneur has created a profitable mini-utility from an abandoned donor-financed plan. It is in these locations, where grid electricity does not reach people who are willing to pay for electricity, given what they already spend on kerosene, that mini-utilities become viable. There are also many examples of community-run mini-grids in countries such as Brazil and Nepal. Community-based power producers may be a good substitute to profit-making entrepreneurs in some areas, especially for very small villages (see box 3.6). However, this report focuses on companies that seek a commercial return on investment and are either profitable or potentially profitable. Hence, ventures with a purely or largely social mandate fall outside its scope. 77 CHAPTER 3 Box 3.6 Community-based systems have a role to play It is important to distinguish between firms that follow 4,500 kilometers of power lines supplying power to 80,000 a fully (or mostly) commercial model, and mostly donor- customers in 36 municipal areas and to rural communities, funded community power producers and village cooperatives. and had a turnover of $12.8 million in 2009. Another large- There are notable exceptions, but most often community- scale example is the United Nations Development Programme’s based systems are difficult to grow, or prove unsustainable, (UNDP’s) multifunctional platforms in Burkina Faso, Mali, often due to complicated local, institutional, and governance and Senegal, in which almost 2,000 micro diesel generators arrangements and associated incentives. A World Bank have been installed. This initiative has facilitated productive, surveya of small power providers found that most systems in income-generating activities for thousands of local women with Bangladesh and Cambodia are privately run, and are profitable. the added benefit of extension for household electrification in In contrast, most mini-grids in Kenya were community run, some cases. but were less financially sustainable. The survey also included Others are small scale (such as the Intermediate Technology a group of 10 community-based hydro-powered mini-grids in Development Group/UNDP/Ministry of Energy pico-hydrob the Philippines, which were unable to cover their operating system in Kenya), but have been instrumental in demonstrating costs and had an average negative gross operating margin of the value of off-grid approaches and have good replication 17 percent. potential. IBEKA (the People Centered Economic and Despite this, some community-based systems have reached an Business Institute) in Indonesia, too, has been in existence for impressive scale, such as Creluz in Brazil. Started in 1966, this 20 years and brought power to nearly 40 communities using a cooperative procures power from the grid but has also added 4 cooperative model. MW of run-of-river hydropower to the local network, manages Note: a. Kariuki, Mukami, and Schwartz 2005. b. Pico hydro is a term used for hydroelectric power generation of less than 5 kW. While the potential market is much smaller than that for household-level devices, due to higher capital costs and population density requirements, at least32 30 million households could be served profitably by mini-utilities, representing a market of up to $4 billion dollars. As shown in figure 3.13, the levelized cost of electricity generation varies by technology and location, but ranges from about $0.20/kWh for a biomass gasifer or micro-hydro33 plant to US$0.30/kWh for a small-scale wind or solar PV plant to $0.40/kWh for a diesel generator. At an estimated cost to the end user of $8 to $9 a month for basic “lighting plus” services, this is significantly higher than the device alternative. In addition, only a small fraction (the exact share is unknown) of the addressable market lives in villages or close enough to densely populated areas to be connected to a mini-grid. As discussed in Chapter 2, however, if technology costs declined or capital costs were subsidized, the market size would be much larger. Many “single system” mini-utilities are operating profitably where the load is such that efficiently sized systems can be installed, where incomes are sufficient for customers to pay rates that allow companies to make a return on investment, and where the regulatory environment is conducive to doing business. Numerous entrepreneurs are running plants that are cash-flow positive without any public sector financial or other preferential support. They report operating profits of 10 to 30 percent, and returns on equity of 20 to 25 percent.34 Most mini-utilities are simply doing business on their own. HOW COMPANIES ARE SERVING THE MARKET 78 There are also a handful of companies that are growing to multiple and, in one case, several dozen, systems—but it is clear that growth remains a challenge in the subsector. Enterprises such as Husk Power Systems and DESI Power, both biomass mini-utilities in India, are already operating several systems that are profitable on an individual plant basis. To address high corporate overhead, which brings down overall profitability and makes management of the business complex, they are exploring replication using ideas such as microfranchising. But these models are yet to be refined to a point where they become easily replicable and scalable. In addition, financing is a constraint— most mini-utilities are not yet straightforward deals for commercial investors or lenders. But this subsector holds real potential and merits greater attention on the part of operating companies, policymakers, and investors. “Mini-grids offer an important jump from basic household devices because they offer electrification and can support productive activities.” Levelized cost of electricity, US cents/kWh (WGNEQUV 1/EQUV +PXGUVOGPVEQUV Capacity FactorsXCT[ EQPUKFGTCDN[COQPI NQECVKQPUCPFJCXG UKIPKƂECPVKORCEVQP 43 RNCPVGEQPQOKEU GURGEKCNN[HQTUQNCT28 or Micro-hydro 33 1 BiomassRQYGTEQUVKU 26 33 OCKPN[FTKXGPD[HWGN 1 EQUVUOCNNRNCPVUCTG HWGNGFYKVJNQECN 19 17 HGGFUVQEMWUWCNN[CV 32 CEJGCRGTRTKEG 25 8 EQORCTGFVQOCTMGV 19 3 8 &KHƂEWNVaccess to 6 credit ECPKPETGCUG 2 VJGQXGTCNNEQUV Solar PV Mini-wind Biomass Micro-hydro &KGUGN RCTVKEWNCTN[HQTECRKVCN ICUKƂGT IGPGTCVQT KPVGPUKXGQPGUNKMG Solar PV, Mini-wind, /CKP#UUWORVKQPU or Micro-hydro %CRGZ 4,800 3,300 3,800 3,000 850 M9 7UGHWNNKHG 20 20 20 25  9#%%CV ;GCTU RTGOKWORTKEGQXGT VJGTGUKFGPVKCN28RTKEGU %CRCEKV[HCEVQT 20  80 20 80 KP'WTQRG  *GCVEQPVGPVCV/9JVQP YQQFCHVGTHGNNKPICV (WGNEQUVU n.a. n.a. 32 n.a. 0.98 OQKUVWTG M9 VQP + FIGURE 3.13: Electricity generation costs by mini-grid technology Source: ESMAP–World Bank, McKinsey analysis. Note: kW = kilowatt; kWh = kilowatt hour; MWh = megawatt hour; O&M = operations and maintenance; PV = photovoltaic; WACC = weighted average cost of capital. n.a. = not applicable. 79 CHAPTER 3 Mini-utilities: Business Models - How Companies are Serving the Market Unlike household-level device companies, most mini-utilities handle the full value chain in- house, from fuel sourcing to billing and collection (figure 3.14). As shown in figure 3.15, across technology types, connections to the end user are made, power is generated in relatively close proximity to the community being served and, using an often crude distribution network, sold to customers. Importantly, there is also a billing and revenue collection function, generally complemented with a small team undertaking repairs and maintenance to ensure integrity of the infrastructure. Either diesel, Some innovation Generation in Some revenue Monthly metered hydro, biomass, in biomass but decentralized diversification billing or flat-fee solar, or wind mostly known locations and simple model, often technologies distribution collected in infrastructure advance Design / Sales & Billing / Consumer After Fuel R&D Generation Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance For mini-utilities, Even commercial Some use Only a few operating entities struggle government examples of context is vital since to secure subsidies to carbon finance they tend to be financing since finance the income; this regulated sector is fairly connection cost applies to new and not well for customers biomass plants understood by investors FIGURE 3.14: Mini-utilities – how companies are serving the market Source: IFC analysis. R&D, Fuel, and Generation Mini-utilities typically focus less on R&D than device companies, but there are some interesting developments in biomass-based plants, notably in India. Husk Power Systems (HPS), started in 2007 by a U.S.-educated engineer originally from the Indian state of Bihar, opted for a biomass gasification approach in India. It operates 80, 32 kW to 100 kW biogas-based mini-grids in villages across India’s rice belt in the state of Bihar, serving villages of 400 to 500 households. HPS currently reaches about 30,000 households, or about 200,000 people, and plans to add a further 30 plants by early 2012, and eventually to scale-up to 2,000 facilities across India and Africa. The company uses the same biomass gasification technology (based on rice husks, a form of agricultural waste) that farmers have used for some time to power their mills. With support from the Ministry for New and Renewable Energy, HPS modified the technology to allow systems to run purely on biogas rather than in conjunction with diesel, making them more cost-effective. HOW COMPANIES ARE SERVING THE MARKET 80 Other aspects of the value chain have required innovation, as that acquired the license for biomass gasification technology well. HPS supplies three-phase electricity35 using a 220-volt developed by the Indian Institute of Science, Bangalore, and system. Initially, it was unable to find low-cost transformers with technology provider Netpro Renewable Energy. It currently for subsystems and faced a similar challenge with circuit operates four plants serving primarily microenterprises, but breakers. The company, therefore, has invested significantly in also has a household customer base. R&D, crafting a number of tailored solutions in partnership Where biomass fuel is available, thermal plants run on this with Indian engineering colleges and other local experts. This resource can have distinctive cost advantages. HPS typically technology has significantly reduced investment costs, but opts for rice-producing communities and their neighbors, to also led to higher operating and maintenance costs, which ensure a ready supply of husks. It buys rice husks from local the company is now struggling to better manage. To generate cooperatives; incentivized by the prospect of accessing electricity power, they favor primary resources that are locally available, in return, they are expected to sell the feedstock without much and generate power using proven technologies sited close to the margin, further reducing fuel costs. The company puts its cost communities they serve. of delivered electricity at $0.20 to $0.25/kWh and estimates Also in the biomass space in Bihar, DESI (Decentralized Energy that costs could fall to $0.08 as plant use increases from the Systems, India) Power uses standardized gasifiers, which need current level of about 40 percent to 85 percent, in tandem less maintenance than HPS’s proprietary technology. The firm with growing demand from its customer base. DESI Power’s was established in 2001; its founder had decades of experience technology was initially designed to run on 30 percent diesel with traditional energy companies and created a partnership and 70 percent biomass, but with rising diesel costs, it moved with DASAG Seuzach, a Swiss energy technology company to pure biogas engines. Distribution Grid Generator - Carries electricity to - Fueled by diesel, PV, customers wind, gas from biomass digestion, or a micro-hydro system Mini-Utility Employees - Sign-up customers - Collect money - Operate and maintain generator - Fix faults in distribution grid Meter - Measure power consumption - Circuit breaker limits consumption allowed for a fixed monthly bill FIGURE 3.15: Generalized mini-utility operating model Source: IFC analysis. 81 CHAPTER 3 Where hydropower is an option, this is often the basis of electricity generation, since it has no fuel-related operating costs. Rwanda Renewable Energy Promotions (REPRO), for example, uses hydropower for its plant, as do Brazil’s and Nepal’s community-based systems, almost without exception. Diesel, which is generally readily available, is used wherever renewable resources such as hydropower or biomass are not an option. There is no such thing as a typical diesel generation mini-utility business. But if there were, it might look like Vihearsur Electrify Enterprise (VEE), a company serving Vihearsur commune, just outside Phnom Penh in Kandal province, Cambodia. This company (see box 3.7), like many others around the world, uses diesel to fire its mini-grids. The fuel is readily available in local markets and runs in small generators that are easy to operate and have fairly low capital costs. There are a handful of examples of large Western-based companies tentatively entering the mini-utilities space in developing markets, primarily using conventional energy for power generation. In the late 1990s, Electricité de France established a Rural Energy Services Company (RESCO) with local partners in Mali, Morocco, South Africa, and more recently in Botswana. Korayé Kurumba is one such partner. A Malian company established in 1999 by shareholders Electricité de France and Total, Korayé Kurumba 36 has used diesel generators to electrify 15 villages and expects to add a further 8 villages to the system in 2012. The firm serves 4,000 households or about 80,000 people (in this case, counting 20 people per household). Koryé Kurumba is preparing hybrid solar PV-diesel power plants to reduce operating costs and manage the volatility of fossil fuel costs.37 Nigeria’s Bonny Utility Company (BUC) is supplied by excess power from a modern gas-fired turbine operated by parent company Nigeria Liquefied Natural Gas (NLNG). Established as part of NLNG’s community value proposition or CSR efforts (see box 3.8), this gas-turbine-based mini-utility operation is a rare find by most measures, because the capital costs run in the millions of dollars, operations are advanced, and the fuel availability is very specific to its location. ABOVE: The co-owner of Cambodia’s Vihearsur Electrify Enterprise with his generators (Credit: Castalia) HOW COMPANIES ARE SERVING THE MARKET 82 Box 3.7 Vihearsur Electrify Enterprise, Cambodia Vihearsur Electrify Enterprise (VEE) was established in 2007 with $50,000. The partners knew about generating power from running an ice-making business with its own generator. They had seen mini-utilities operating in other towns in Cambodia and realized that such a business was relatively simple to run and could offer steady, reliable revenue. The company has expanded to supply power to 1,760 customers, 24 hours a day. The company plans to add another 2,000 customers over the next two years. VEE’s customers pay around $8.44 for about 13 kWh of power per month. To put the cost in perspective, households that are not connected to a mini-utility may face monthly charges of $20 to $50 a month. Kerosene for lighting could cost $3.50 to $4.00; dry cell batteries and car batteries cost $5 to $7 for light only and $10 to $12 for light plus a small black and white TV. Cell phone charging can cost $3 to $5 per month. Solar home systems or individual household generators cost $30 to $50 per month in this village. Average income levels among VEEs customers are $400 per month per household, or $13 per day per household. Like most mini-utilities in Cambodia, VEE uses a monthly billing system. Users pay for metered use at the end of the month. There is a charge of $50 for new connections. However, VEE will finance 50 percent of the connection charge for one year at zero interest and offers $10 to help pay for household wiring. In addition to price, key value propositions include the fact that villagers want to watch TV, that students can study at night, and that private schools can operate at night. Small businesses use power to operate a range of machinery. Total investment in the business is now $250,000. Of this, $60,000 is funded with loans from commercial banks (ACLEDA Bank, a local commercial bank loaned $50,000, with a four-year tenor and a 13 percent interest rate; and ANZ Royal Bank loaned $10,000 with a two-year tenor and a 12 percent interest rate per year). The Rural Electrification Fund provided $45,000 in grants; this is in the form of a $45 connection subsidy paying for 1,000 new connections. The remaining $145,000 is the shareholders’ equity investment. The company sells 270,540 kWh per year at an average rate of $0.65 per kWh, for annual revenue of $175,848. After expenses, including interest, the company’s profit is $40,956, a return on equity of around 28 percent. To strip out the effect of the subsidy, it can be assumed that the $45,000 in grant funding had instead been borrowed on commercial terms at 12 percent interest. Interest costs for the year would have been $5,400 higher than they actually were, reducing net profit to $35,556, for a 25 percent return. 83 CHAPTER 3 BOX 3.8: Bonny Utility Company, Nigeria The Bonny Utility Company (BUC), a mini-utility operating from under 250 kWh per year to 960 kWh per year, a power on Bonny Island in Nigeria, is remarkable in that it is a CSR availability of over 98 percent, and nearly 200 full-time jobs initiative that is transitioning into a financially sustainable created. operation. BUC has had to overcome several stumbling blocks on the road Taking advantage of a government decree allowing private to success, notably initially not consulting with or involving power generation and distribution, Nigeria Liquefied Natural the community in its design or otherwise giving them a Gas (NLNG) signed a memorandum of understanding with sense of participation and ownership, tolerating low levels of the local community and negotiated a contractual agreement to professional management, and miscalculating both pricing and supply power on the island. In the same spirit, the business is run demand. Lessons learned include: under an inclusive governance structure bringing together the oil industry, local leaders and representatives, and government 1. Declare the venture part of the mother company’s core officials. BUC offers customers a progressive tariff schedule business comprising six levels; there is a free basic allowance followed by • Ensure that there is a champion of the project within increasing energy charges as a function of consumption. As a top management of the company; do not leave design of result, customers—who range from low-income households to strategic projects in the CSR department. larger service sector businesses—receive an indirect subsidy of • Ensure that there is adequate organizational support from zero to 70 percent. and that other areas of the business are leveraged where Contrary to market practice in many parts of the world, low- appropriate, for example, in gaining access to logistics consumption users are subsidized by heavy consumers, and not teams and in securing fuel supplies for the system. the reverse. The utility uses prepayment metering and cash- • Link community development to company management free transactions to collect revenues. Customers—including and operational targets so that projects achieve both businesses—pay their bill in advance at one of several bank financial and broader development objectives. branches in the vicinity, based on an estimated consumption for the month ahead. Proof of payment need not be presented 2. Plan to be in the game for the long term to BUC’s front office, since end users receive a 20-digit token • Bring stakeholders along, even if they risk initially directly from the bank teller, which is inserted into the meter. A slowing project implementation. Rather than rush the central system allows BUC to track usage and alerts operators of process, ensure that project lead times are long enough to any irregularities, and each connection is checked twice a year. accommodate it. A back-up meter can check whether customers have attempted to bypass the system. Nonpayments and irregular payments are • As part of a “shared social contract,” develop a sense of estimated at 1.3 percent. ownership among stakeholders, build commitment to ensuring their continued involvement over time, and Currently, BUC serves 9,300 customers (corresponding to about develop roles to help ensure that involvement. 75,000 people), essentially covering the entire island via its 50 3. Make clear agreements kilometers of distribution network. Approximately 40 percent of the company’s customers enjoy free service without buying • Avoid ambiguous deliverables. List both what the business credits, a further 40 percent are small residential customers venture will do and what is excluded. For instance, it will paying up to $6.50 per month, and the remaining 20 percent provide electricity but not cooking fuels. are commercial customers, who account for 70 percent of sales • Do not cluster projects. Be explicit about individual project owing to their higher tariff levels. The mini-utility earns an components, what their objectives are, and how and when estimated monthly revenue of $37,000. In 2010, the company’s they will each deliver against specific milestones. annual revenues were $500,000, but they are projected to • Define a clear exit strategy. At what point and under what increase to $1.9 million by 2015. conditions and to whom will the mother company spin A total of $6.5 million has been invested in modern facilities, off the venture? What are the post-handover activities with connection costs of about $760 being a major cost driver. that must be undertaken to maintain the operational This investment has provided five years of disturbance-free integrity, financial viability, and social and environmental operation for NLNG. There has been high local development sustainability of the business? impact, with per capita electricity consumption increasing • Keep all communications formal and in writing. HOW COMPANIES ARE SERVING THE MARKET 84 ABOVE: BONNY UTILITY COMPANY SUBSTATION, GRID SUPPLYING A TOWN AND CUSTOMER SERVICE CENTER (NOTE THAT THIS IS NOT A COMMUNITY MINI-GRID) (CREDIT: BONNY UTILITY COMPANY) 85 CHAPTER 3 Distribution & Sales Mini-utilities generally use simple wiring systems to distribute power—without the need for a transmission system—from the generation facility directly to household and business customers. Distribution lines may be built out on poles that would not meet utility standards elsewhere. This helps lower the cost of building infrastructure, but can also come with the downside of reduced reliability and service standards. Given that loads are difficult to estimate and manage in a small grid with little diversification, smart grid technologies can help manage loads more effectively and improve overall performance, such as by prioritizing certain loads or sequencing them in “waiting lists” so as not to overstress the grid. Research on such smart mini-grid applications is currently under way in various places, including at TERI (The Energy and Resources Institute) in India. LEFT: Husk Power Systems power lines on rough overhead poles; RIGHT: A Husk Power Systems biomass plant (Credit: Husk Power Systems) Most mini-utilities distribute and sell directly to consumers or small businesses, but there are exceptions. For example, DESI Power serves microenterprises directly but reaches households via entrepreneurial intermediaries, rather than distributing directly to the microenterprises. These retail suppliers purchase power from DESI and can set their own prices and collection schedule with end users based on the services provided. Households are typically charged a daily rate of about $0.10 for sufficient power to run a 60-watt bulb during evening hours. DESI’s business customers are either charged on a per-kilowatt-hour basis or a set rate, for example $1.15 for an hour of irrigation pumping, which is slightly below what they would pay for power from a diesel generator.38 HOW COMPANIES ARE SERVING THE MARKET 86 Mini-utilities need to recover fi xed costs and achieve an acceptable rate of return, which makes it critical to ensure that customers purchase sufficient volumes of power. Poor customers can typically only afford a small number of appliances and therefore have limited electricity consumption, so mini-utility companies use a range of strategies to achieve requisite sales volumes to make their businesses viable. Philippines-based Power Source, for example, has an innovative approach that it calls a “Community Energizer Platform.” This is a modular system in which one container holds a generator while others house electric-powered equipment that can be valuable to the community, such as water purification systems, communications (cell phones, computer, Internet, fax), refrigeration, ice-making, and entertainment (a movie theatre and small video game parlor). These modules both supply power to the community with limited distribution infrastructure, and create the demand for that power by offering services that require electricity, and are considered to be important for individuals or groups within that community. Other mini-utilities have bolstered income by developing a more diversified revenue base. REPRO, for example, supplements household billing income by feeding surplus power back to Rwanda’s national utility. BUC in Nigeria has instituted one of the more sophisticated revenue models by securing contracts with “anchor” commercial clients to help subsidize less profitable poorer customers. The benefit of anchor clients is that they assure demand for the power generated, allowing for better planning and growth. With larger customers providing the backbone of its income, BUC is able to slash tariffs for low-consumption customers, many of whom pay little or nothing thanks to its multitiered tariff system. HPS is diversifying its current business beyond households to serve SME clients and, beyond power, is beginning to sell rice husk char39 and to tap carbon payments, the latter of which is estimated to contribute about 5 percent of revenues today, but which could account for as much as 50 percent of total sales by 2014. Billing & Collection Where ensuring that customers in extremely poor areas pay for the electricity that they consume is a challenge, mini-utilities are innovating in how they bill and collect revenues, with good results. Given the value of electricity to customers, most companies do not face major issues in collecting revenues. Indeed, companies report that developing a close relationship with the community is an important element of their business. Nonetheless, billing and collection approaches are being designed with the BOP in mind. For example, HPS started with a fi xed price model that enabled each household to run two 15-watt compact florescent lights plus charge their mobile phones for 50 rupees, or about $1 per month. In time, HPS adjusted its pricing model to reflect increasing fuel costs and to help optimize technical systems by requiring that each household sign up for two 45-watt connections. The approach allows each HPS mini-grid to be sized at 30 kW and, operating at 50 percent capacity, to serve about 1,000 to 1,050 connections, which is the average size of its target communities. Customers must also pay a connection cost of 100 rupees (about $2) to take the distribution network to their homes, and purchase the light bulbs that they use. The unit cost to the end user is about $0.25 per kWh. A 1,000-watt package is also available for customers with greater needs, and is priced at a significantly lower rate of $0.17 per kWh. 87 CHAPTER 3 HPS has also introduced several methods to ensure bills are paid, including up-front collection of payments by incentivized door-to-door collectors, who double as electricians. In addition, the company has installed simple circuit breakers that switch off if a client’s load rises above their payment level (these are a cheaper solution than installing meters). It is experimenting with low-cost meters in an attempt to diversify its customer base to include industrial customers. HPS secures commitments for household connections before starting operations in a new area, asking for a deposit of one to three months’ consumption to ensure that customers are able to make payments. This is done either directly by HPS or by local entrepreneurs who are recruited as quasi-franchise holders to invest in and run individual networks. Shared Solar is in the early stages of developing a pay-as-you-go micro-grid in Mali that allows customers to buy even small amounts of electricity “on demand” using an automated up-front payment collection system. Shared Solar installs a grid-quality 220-volt distribution network within a given community, which can serve as a distribution network later when grid power arrives. In the interim, a company- owned solar source with battery backup is the basis for power generation (see figure 3.16). Customers pay by purchasing scratch cards from local vendors and sending a text message with a single-use code to the network operator. Tentative assessments indicated that users are willing to pay as high as $3 for the first kWh each month, enough for cost recovery of the solar system. Consumer Financing Perhaps more than anything, connection costs often prevent poor households from benefiting from decentralized power producers. The cost of connecting a customer to a mini-grid varies greatly, depending on the distance that a wire must be extended, but can be significant. In Mali, for example, RESCOs charge a deposit and connection fee of $45 to $378. Solar System Controller Cellular Network Gateway Meter Logs Shared Solar Modem Metering Meter Service Commands Meter Database Administrative Vendor Interface Tablet-PC FIGURE 3.16: Shared Solar PV metering concept Source: Shared Solar. HOW COMPANIES ARE SERVING THE MARKET 88 This also reflects the cost of public or community energy services, such as street lighting, provided by the companies. Where available, government subsidies to broaden service can make a significant difference in removing the major barrier of up-front costs. There are a number of examples of subsidies being offered for mini-utility connections, with good results. In Tanzania, $500 per connection, provided by a World-Bank-funded program and channeled through the Energy and Water Utilities Regulatory Authority, helps to cover network costs. As part of the Cambodian government’s policy to expand access to electricity, all mini-grids in the country now receive a $45 output-based subsidy (which is released once the mini-utility provides proof that the connection has been made) for each additional residential customer connected. Many companies use these funds to build out their distribution network further. VEE, however, has decided to pass this subsidy on to the customer in the form of a reduced connection charge. The company yields a return on equity of around 28 percent, or 25 percent if adjusted for the government grant. This seems to make good commercial sense, especially given that total returns to equity are expected to increase over the medium term because incomes in the area and power sales per customer are rising faster than new investment required, and access to loan financing can be increased accordingly. Arguably, VEE would be commercially viable even without grant funding, but the per-connection subsidy makes it profitable to extend service to lower-income and more remote areas than otherwise possible. Mini-utilities: Key Success Factors in the Business Model The key factors that determine the success of a mini-utility are tied to the operational efficiency of a capital-intensive business and what it takes to replicate it. The three conditions are: • Ensuring adequate demand for electricity • Securing a low-cost primary energy source • Developing the right operating model—and ensuring sufficient management expertise—to scale the business beyond a handful of systems (see figure 3.17). Reliable low-cost Adequate primary energy population (fuel or density and load feedstock) factor Design / Sales & Billing / Consumer After Fuel R&D Generation Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance Entrepreneurs with technical expertise and business acumen to scale operations FIGURE 3.17: Key success factors in the mini-utility business model Source: IFC analysis. 89 CHAPTER 3 Ensuring adequate demand for electricity There are essentially two types of mini-utilities—“lighting- focused” and “total electrification” types. Lighting-focused Where there is high electricity demand in a tight geographic mini-utilities, such as HPS and VEE, can estimate their load area, a standard grid-based system can likely supply power at a curves relatively easily based on demand, making plants more lower cost than any other energy service model. Similarly, mini- efficient. This might facilitate scalability but limits profitability, utilities work best when communities are too remote to connect since households are lower-profit, lower-consumption to the grid, but have high population density. If customers are customers. The total electrification operators, such as BUC, located far from each other, or when usage per customer is low, DESI, and Power Source, aim to provide all the electrification the cost per kilowatt per hour from a mini-utility increases. needs of an area. This allows for large baseload customers and Sufficient population density is therefore a key determinant higher fees, but requires a greater amount of capital investment. when deciding among energy options. Where communities Commercial and productive demand can make a major that are far from the grid have a high population density, difference to the required load in an area, and hence to the they may be most economically served by mini-utilities.40 As viability of a mini-utility. These include power consumption the distance between houses increases, however, solar home from agriprocessing, trade, refrigeration, and communication systems become more economical, because they do not require technologies. As mentioned, Power Source’s “community load a distribution system. centers” create demand from small businesses. DESI Power also Beyond population density, income levels in an area also help focuses on the establishment of micro- and small enterprises determine mini-utility profitability—but they do not need through two partner organizations.41 DESI is likely to focus to be very high to allow viable mini-utilities. No matter how increasingly on establishing plants where there is already densely populated an area, if customers’ incomes are so low sufficient demand for power. that they spend very little on power or require limited power Adequate electricity demand can also be secured through for appliances, then mini-grids may not be the best option to offtake agreements with industrial anchor customers. Power provide the energy services they need; devices are potentially demand in many areas may not initially be enough to justify most realistic. investment in a mini-utility, even though demand may grow to Encouragingly, as mentioned, incomes need not be very high to a level that allows it to be profitable after the grid is installed. This paradox is a traditional justification for government allow mini-utilities to be viable, since a basic level of electricity subsidy of rural electrification. A far better alternative is for service can be supplied for less than $5 per month. VEE’s mini-utilities to set up new operations with offtake agreements customers, for example, which are typically households with with industrial customers that will provide long-term demand five or six people and which pay a little more than $8 per month for baseload power. for power, have an average per capita income of $2.60 per person per day. While the delivered cost of diesel varies significantly BUC relies on a solid SME customer base for its operations. depending on how remote a community is, VEE’s cost levels DESI Power did not start operations this way but is collaborating are somewhat indicative of what could be achieved in many with the Rockefeller Foundation on a pilot project (SPEED) places with equivalent population density. HPS’s lower variable designed to link their plants with mobile phone base stations, (fuel) cost allows it to sell power at around $2 per household per so that tower demand would serve as the baseload. Though month, so the company can serve households with much lower still in the early stages, Andoya Hydroelectric Power Company income levels, increasing market size. The HPS cost structure is Limited, located in Mbinga Township some 1,000 kilometers harder to replicate, given the need for a specific feedstock, such from the capital city of Dar Es Salaam, is one of the local as rice husks, for production of biogas. But as shown in figure companies taking advantage of Tanzania’s attractive mini- 3.13, other technology choices that might have higher capital utility framework (see box 3.9) to capture all of these market costs but little or no operating costs (such as hydropower, PV, constituents. It takes advantage of a Standardized Power and wind) can generate power for under $0.33 per kWh or less Purchase Agreement, which was introduced by the energy than $5 per month, assuming electricity consumption of 13 regulator to replace some or all of the rural diesel-based power kWh per month for very basic service, as is the case for VEE. generated by national utility Tanesco with power procured from private operators. HOW COMPANIES ARE SERVING THE MARKET 90 Box 3.9: Government policy drives mini-utility outcomes: Encouraging private developers in Tanzania To help meet Tanzania’s need for power, improve electricity access, and foster domestic private sector investment in small clean power sources, the Ministry of Energy and Minerals developed the small power producer (SPP) program in 2009. The detailed implementation rules and guidelines were developed by EWURA (the Energy and Water Utility Regulation Authority) with assistance from the World Bank. These rules and guidelines encourage the development of renewable and cogenerated electricity through a combination of standardized power purchase contracts, feed-in tariff (FIT) payments, and streamlined interconnection and licensing requirements. The regulations provide the legal basis for private businesses and individuals to interconnect renewable energy generators into isolated mini-grids and to export excess power (up to 10 MW) to the national utility, Tanesco. This provides additional revenues to those from local communities but also, importantly, creates the demand needed for systems to be sized optimally. Eligible projects must be at least 100 kW but no more than 10 MW. This means that, for example, a 17-MW biomass SPP powered by sugarcane bagasse could participate in the program as long as it uses at least 7 MW to power the host sugar factory and supplies a maximum of 10 MW to the grid. Future revisions to the regulations, currently in early stages of discussion with EWURA, may also create a category of very small power producers (VSPPs) with further streamlined regulations for projects less than 100 kW. Tanzania currently has two FIT levels for wholesale sales of electricity by SPPs. The tariffs are calculated and paid in Tanzanian shillings (TSch). The first FIT is for SPPs selling electricity to the national utility Tanesco’s main grid. It is differentiated by dry and wet season, and its current average value for 2011 is 112.43 TSch/kWh (6.7 U.S. cents). A second, higher level is for SPPs that sell electricity to one of Tanesco’s isolated mini-grids that currently receive electricity from diesel generators. Its value for 2011 is 380.22 TSch/kWh ($0.23). Both FIT values are based on annual estimates of different measures of Tanesco’s average avoided cost on the main grid and on isolated mini-grids. At the time of writing, Tanzania appears to be the only country in Sub- Saharan Africa that uses the buying entity’s avoided cost to set FIT values. Elsewhere in Africa, FIT values are based on estimates of the renewable generator’s technology-specific cost of service. A third approach, based on structured competitive bidding, was announced in South Africa in 2011. The result of these efforts has been a marked increase in interest on the part of private players in developing mini-utilities in various parts of the country, some as cogeneration and others on a stand-alone basis. One such developer, Andoya Hydroelectric Power Company Limited, is profiled in Chapter 3. 91 CHAPTER 3 Andoya will sell about 85 percent of its generation to the national utility, its anchor client. The remaining 15 percent is distributed directly to about 1,000 households in three villages and to other local businesses, like mobile phone base stations in the vicinity directly via its own mini- grid. Operated by a local businessman whose ventures include milling and transportation, the 500-kW small hydro plant substitutes diesel use in the local utility mini-grid and businesses, creating a win-win for all constituents. The developer gets preferential feed-in tariffs42 to recover the investments while the customers reduce their current diesel-based power bill by more than half. Securing a low-cost primary energy source Securing reliable, low-cost primary energy is a major challenge for mini-utilities. If mini-utilities can be commercially viable where population density and customer willingness to pay is sufficient, what explains their relatively low penetration into this huge market? Part of the answer lies in their ability to access reliable, low-cost energy sources for their power generation systems. Where the terrain is suitable, run-of-river micro-hydro systems can offer a good—and essentially free— resource. Solar and wind can also be reliable and result in low running costs. But mini-utilities must ultimately make the trade-off between capital and operating costs, and these renewable technologies are generally very capital intensive. The extent to which the primary energy can be transported to, or stored for use at, specific sites is another consideration. While solar energy is generally abundant in developing countries, wind resources are variable, and hydro energy much more so. While most companies opt for diesel fuel, biomass fuels are increasingly being explored as a cost-effective option for mini-utilities. Biomass can be a reliable, low-cost fuel, especially when it comes from crop waste. HPS’s rice husk fuel, a by-product of rice milling, has a low value in alternative uses—currently it sells for about $22 per ton. At that price, its fuel costs amount to $0.04 per customer per month. There is an increasing interest in rice husks as a fuel source in Cambodia, too. Batdeong Electricity uses husks to make biogas, using a digester from Ankur Scientific Energy Technologies in India. As a result, its fuel costs are estimated to be about 72 percent lower than diesel-fired VEE’s costs, also in Cambodia. But biomass-based mini-utilities must manage their fuel supply chains and transportation costs carefully to maintain profitability. Where its use is widespread, and demand for feedstock increases, biomass price volatility can become an issue. For example, supply uncertainty and price pressure could come from competition with animal feed producers and industrial energy cogeneration, both of which can use crop waste. Or there may simply be an issue with suppliers seeing more value in what was previously considered a by-product. HPS saw rice husk feedstock prices rise about 35 percent in 2011 because it has not been able to secure long-term contracts for reliable supply. HPS buys rice husks from cooperatives or from centralized rice mills, which purchase them from local farmers in the mini-utility’s service area. Indeed, the basis for establishing its plants in certain communities has been the availability of fuel and a good informal relationship with producers. But, over time, the cooperatives and mills do not necessarily continue to share the incentives of individual farmers that HPS supplies. In addition, changes in the price of diesel can result in spikes in the transport costs for getting the fuel to the plant. To manage both fuel supply chains and cost structures, biomass mini- utilities may need to enter into long-term guaranteed contracts with cooperatives or other third parties and build storage facilities to manage price volatility. Alternatively, they could consider introducing flexibility in terms of the fuel options with which systems can operate. Finally, developing proprietary plantations near their mini-utilities may also help to manage costs. DESI’s HOW COMPANIES ARE SERVING THE MARKET 92 gasifiers can run on a range of biomass including rice husk briquettes, sugarcane toppings, corn cob, mango kernels, coconut shells, and woody biomass. To further control fuel reliability and manage variable operating costs, DESI is also considering cultivating fast-growing wood crops on its own plantations.43 HPS is beginning to use a mix of rice and wheat husk, and is also adjusting its plants to use bagasse, sawdust, jute, and other biomass fuels. “Interestingly, formal skills are not a key success factor for most small power providers, but they do become critical for mini-utility scale-up.” Developing the right operating model—and ensuring sufficient management expertise—to scale the business beyond a handful of systems Formal business skills are not a key success factor for most small power providers operating a single, often diesel-fired, plant. Most mini-utilities are started by local business entrepreneurs with some background in running a small company and in the operation of engines or electrical systems. They often thrive when the entrepreneur has some basic business skills, technical knowledge, a good understanding of the locality, and some capital of his or her own to invest. But, interestingly, formal “utility business training” is not a key success factor for most small power providers. A survey across Bangladesh, Cambodia, Kenya, and the Philippines found that only 20 percent of small power system operators have a technical secondary school or university degree. Skills development and capacity building are not major concerns for most small power providers.44 And as with the VEE example, where small diesel systems are used, the technology is quite simple, and the skills are not difficult to acquire. Renewable energy, hybrid, or larger fossil fuel systems, however, require higher levels of technical sophistication to operate smoothly, and entrepreneurs often benefit from focused training. Training has contributed to the success of the Bonny Utility Company in Nigeria, which serves over 8,000 customers. There, parent company Nigeria Liquid Natural Gas has implemented a capacity-building program to train local entrepreneurs to take over operations from NLNG employees within a given time frame. They have also built the distribution grid to conform to international standards, and instituted a safety culture, leveraging the mother company’s expertise. This is also true for mini-utilities with operations at several sites. HPS has realized that, in order to scale-up beyond its 72 systems currently in place in Bihar to some 2,000 installations across India and in parts of Africa, it must have a growth-oriented business model and a high- caliber management team to design and oversee a complex rollout. On the business model side, it is exploring franchising. Under a franchise system, entrepreneurs would front a portion of the capital for a mini-grid system and HPS would facilitate financing to cover the balance—through its own books or by guaranteed bank loans—and would provide operational support. HPS is receiving advisory support from IFC to help design information systems to manage a growing span of control, and to develop a tailored training program for operators and mechanics to run new plants. In tandem, it has invested almost $500,000 in a capacity-building venture called “Husk University,” which aims to develop a cadre of entrepreneurs to efficiently run its systems using a combination of classroom and on-site programs. 93 CHAPTER 3 What is clear is that investment in strategy and formal management skills becomes critical for companies that want to develop scalable business models—not an easy feat for most small power producers. HPS, for example, is struggling to secure the capital needed to develop its franchise approach because banks are simply not willing to take the risk on such an early-stage venture. And while HPS is profitable at the plant level (see figure 3.18), corporate overhead costs are high as a result of a fairly large, top-tier management team. Some companies—such as Electricité de France in Botswana—are exploring approaches to addressing this challenge, but it is clear that more needs to be done to help systems get to true scale. Biomass mini-utility, India Plant investment of $35,000 Revenue assumes sales of 20 kW of total 32 kW capacity Electricity Carbon Additional Biomass At $6,700 annually, operating sales credits revenue ** Total feedstock profit margin and unleveled 1,000 0 16,600 3,500 return on equity is 20% (without subsidy) 15,600 Revenues allow equipment to break even in 5 years assuming $, per 32 kW plant, annually 18% discount rate Labor 4,600 Maintenance expenses 1,800 20% 6,700 Revenue Costs Margin *Assuming 8 hours of operation per night and carbon trading price of $9/CER, 125 CERs per plant. **From sale of biomass-related by-products. 32 kW plant adds $1,125. Adjusting for monitoring costs, revenue is about $1,000 annually. FIGURE 3.18: Indicative cost structure of mini-utility, example from India Source: Interview with company staff. Mini-utilities: Key Success Factors in the Ecosystem Environment Mini-utilities show promise for electrifying remote areas, but face fairly high capital investment and are complex to operate; therefore, they require a broader supportive framework to do well. The ecosystem conditions that are proving key for the success of mini-grid businesses are45: • Being allowed to operate, and to do so in areas that are viable to serve • Not facing onerous mini-utility licensing and permitting barriers • Being allowed to charge tariffs that are commercially viable • Accessing long-term debt and equity to support start-up and growth • Accessing concessional financing to help cover connection costs, and sometimes other capital costs (figure 3.19). HOW COMPANIES ARE SERVING THE MARKET 94 Design / Sales & Billing / Consumer After Fuel Generation Marketing Sales R&D Distribution Payment Finance VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance Setting mini-grid Allowing Removing Accessing long- Accessing tariffs at mini-grids to onerous licensing term debt and concessional com mercially operate and do and permitting equity to support financing and viable rates so in areas that barriers start-up and sometimes are viable growth capital to cover connection costs FIGURE 3.19: Key success factors in the mini-utility ecosystem conditions Source: IFC analysis. Being allowed to operate, and to do so in areas that are viable to serve More so than in the device space, the legal and regulatory contexts within which mini-utilities exist are critical for financial viability. Simply put, mini-utilities should be allowed to operate and to do so in areas that are viable to serve. Perhaps surprisingly, this is not always the case—in some countries mini-utilities are not permitted. And, as discussed later, in others they are subject to arduous regulations or non-cost-reflective tariffs. Where the right environment exists, profitable businesses operating one or a handful of plants can typically be found, and are common in places like Cambodia and the Philippines. For most of the 20th century, the common approach to the regulation of all electricity distribution systems was to grant exclusive rights to serve an area. The arguments for this approach appear reasonable in principle: electricity distribution is a natural monopoly with economies of scale, so it would not make sense to have multiple utilities supplying one area. Moreover, utilities rolling out into areas that are costly to serve likely need assurance they will not suffer excessive competition. Finally, the utility may need competition to be restricted in the urban areas in which they have a presence in order to effectively cross-subsidize rural locations, with most profits made serving the towns. This can work well. In Grenada, Jamaica, and St. Lucia, for example, utilities operating under exclusive licenses have achieved universal electrification. However, when a central utility does not have the incentives, cost structure, or capacity to reach grid extension goals, exclusive or monopoly rights can be counterproductive. One or more of these constraints may prompt a centralized utility to leave some communities without electricity, while the law prevents any other enterprise—for example, a mini-utility from a neighboring area—from serving those communities. In Indonesia, for example, the state- owned power company PLN has a constitutionally provided monopoly on power distribution. 95 CHAPTER 3 Although PLN serves only 65 percent of the population, other companies cannot supply electricity to the remaining third of the population without express permission from the company, which it has so far withheld. Meanwhile, research commissioned by the World Bank shows that rolling out mini-grids in a number of areas in Indonesia would be technically and commercially viable.46 Indeed, in countries like Chile, which developed a national electrification program in the early 1990s, the lack of exclusive distribution rights was an incentive for companies to participate in the market as a strategic move to protect their existing distribution areas and reduce the threat of competitors entering certain areas.47 In the last decade, countries with significant areas unserved by the grid have relaxed previous legal monopoly arrangements, allowing independent companies to offer varying degrees of services in the concession areas. Appendix C provides examples, the most notable of which are India and Nigeria. Exclusivity that lasts beyond a limited period will generally reduce, rather than increase, energy access.48 Exclusivity is only necessary where there is a threat of competition, but this threat almost never exists in reality. Electricity distribution networks are natural monopolies; once they are in place, it is never economic to duplicate them. Conversely, allowing off-grid providers to operate in areas notionally under a concession but not served by the grid can increase energy access and apply pressure to operators to expand their grids where viable. Possible reasons for limiting competition might include protection for cross-subsidies, or the promotion of economies of scale to lower costs in the medium term. However, these goals can be achieved by offering exclusivity for a limited period—up to the target date for the rollout, say. Not facing onerous mini-utility licensing and permitting barriers Mini-utilities thrive when they are free from onerous licensing and permitting barriers. Even where mini-utilities are not blocked by exclusive franchises, they are still often stymied by onerous licensing procedures and conditions. The Philippines is a case in point. The Electric Power Industry Reform Act passed in 2001 contained provisions specifically intended to allow mini-grids to operate in unserved parts of the country. However, it took until 2006 for the regulator to issue the necessary rules to implement this provision. These rules included requirements for designation of unserved areas by the authorities, followed by public hearings and a commission decision to allow a mini-utility to operate. In the five years since the rules were promulgated, only one company (Power Source) has managed to negotiate the regulatory red tape and become legally qualified to serve the market. The other micro- grids remain illegal. As a result, they cannot access finance, nor can they grow or formalize their operations, for fear of attracting attention from the authorities. In Kenya, the Energy Act 2006 provides that energy undertakings with a capacity of less than 3 MW do not need licenses, only permits. This is presumably intended to facilitate mini-grids. But the rest of the act makes little distinction between licenses and permits in terms of requirements or procedure. (See box 3.10 for the example of Nepal.) “Exclusivity is only necessary where there is a threat of competition, but this threat almost never exists in reality.” HOW COMPANIES ARE SERVING THE MARKET 96 ABOVE: AN AFRICAN CLOTHES MAKER SEWING BY THE LIGHT OF A SOLAR LANTERN (CREDIT: IFC) 97 CHAPTER 3 Box 3.10: Government policy drives mini-utility outcomes: Community power in Nepal Though different from Tanzania, Nepal is also an interesting case because over 2,000 micro-hydro mini-utility installations deliver 85 percent of off-grid electricity supply to 14 million households in a country that has one of the lowest rates of electricity use in the world (see figures B3.10a and B2.10b). (About 17 million Nepalese have no access to grid supply, and these households are predominantly rural.) This is a remarkable delivery of renewable off-grid electricity, and it has been driven by government policy, starting in 1975, which has together with donor-funded programs progressively promoted micro-hydro systems. Community involvement is mandatory for subsidies 19 19 100% 3% Ownership entities (%) 12% 23% Households electrified in ‘000 20 17 3% 14 15 50% 9 8 9 8 10 7 85% 97% 77% 6 6 5 5 5 4 3 3 0% 1962– 2006–07 2007–08 2008–09 1994 1997 2000 2003 2006 2009 Houses electrified through micro & pico hydro Installations of micro-hydro Community Owned Privately Owned Cooperative No Response FIGURE B3.10a Number of households electrified through FIGURE B3.10b Ownership of micro-hydro installations in Nepal pico- and micro-hydro schemes Source: IFC 2012; Intellecap analysis. Source: IFC 2012; Intellecap analysis. This success in delivering energy to rural areas has, however, provided limited commercial opportunities for the private sector. The reason for this is that the design of policy drives remote installations that supply homes (which mostly only require lighting) and does not emphasize the relevance of baseload anchor customers for the success of operators. This, combined with a low ability of end users to pay, high installation costs, and operational challenges (also common to mini-utilities in other countries) has limited the opportunities for entrepreneurs. In addition, policy design requires community involvement and specifies which technologies may be used for companies to qualify for subsidies. The lesson to governments is that policy guides the outcome; in this case, policy decisions have largely made private sector involvement in mini-grids inviable. HOW COMPANIES ARE SERVING THE MARKET 98 The success of mini-utilities in Cambodia and, increasingly, Clearly, mini-utilities should be allowed to charge commercial India is attributable primarily to regulatory regimes that allow prices to willing customers. There is a difference between a them to exist. These examples provide models of regulatory newly established mini-grid company bringing power to an approaches that may be valuable for other governments that area for the first time, and a utility that has been serving an would like local mini-grids to operate in unserved areas. area for many years. When a service is provided for the first time, customers have a genuine choice and will switch to the The first lesson from Cambodia is simply the value of removing restrictions such as exclusive franchises, licensing, and tariff new provider only if it offers better value for money than regulation. Mini-grids started to operate in Cambodia soon their traditional solutions. In addition, in off-grid and mini- after the country’s civil war ended. Government capacity was grid situations, where power is typically used for very basic very low and unable to reach most of the countryside. In this applications such as lighting, operators compete not only with completely unserved and unregulated environment, people kerosene lanterns but also with solar lanterns and solar home started to buy generators and sell power to their neighbors. systems. In Mali, the RESCOs are allowed to set their own Mini-utilities sprang up in many villages. Since those early tariffs, walking the line between affordability for the customer days, the regime in Cambodia has evolved to regulate these and allowing an acceptable rate of return for the supplier. enterprises, but with a light touch that allows the enterprises to prosper and grow. Companies such as VEE and Batdeong are The risk that tariffs are set so low that mini-utilities become now licensed by the Electricity Authority of Cambodia. The inviable, preventing customer choice altogether, probably granting of such licenses has allowed mini-utilities to borrow outweighs any risks of monopoly profit. Why not allow the from commercial banks. The Cambodian regulatory regime market to determine what mini-utilities can reasonably charge? also provides a framework that allows off-grid systems to Indeed, it seems odd to worry about the risk of monopoly connect to larger utilities, purchase cheaper power from those profits in an unelectrified rural area when the generally utilities, and then on-sell that power to their customers at a accepted view is that these areas cannot be served profitably regulated distribution margin. at all. If the objective is expanded energy access, then allowing mini-utilities to make profits so as to access capital, grow their India’s reforms offer a good model for those countries that systems, and serve even larger populations would be a more have working regulatory regimes they wish to preserve, while logical direction for policy. simultaneously allowing mini-grids to serve communities that lack power. In all fairness, Cambodia is an extreme case, and there is no need to abandon all regulation to get mini- grids working. What is essentially required is to legalize their “It seems odd to worry about operations to put them on a sound regulatory footing so that they can do the essentials, such as raising debt. India’s Union the risk of monopoly profits in Government Electricity Act of 2003 allowed mini-utilities to operate without licenses in rural areas49 providing they comply with safety standards. These reforms have encouraged firms to an unelectrified rural area when start up, and should be replicated elsewhere. the generally accepted view is Being allowed to charge tariffs that are that these areas cannot be served commercially viable profitably at all.” Mini-utilities are generally subject to tariff regulation intended to protect the consumer. But, if set at inappropriately low levels, this stifles the sector. In Nigeria, mini-grids are legally allowed to operate, but need a license if they are over 100 kW in capacity, and may charge no more than the regulated tariff set for large distribution companies. While well intentioned, this often makes it unprofitable to run smaller systems, which invariably face higher costs and lower economies of scale than the grid. 99 CHAPTER 3 While the notion of unregulated mini-grid tariffs may seem unusual or even risky, it is reasonable from an economic perspective. Regulation of prices is used for monopolies. But a mini-utility entering a market is competing with many other energy sources besides the grid. And unregulated tariffs not only help energy access, but also create a competitive price environment, which will ultimately protect consumers. Accessing long-term debt and equity to support start-up and growth Mini-utilities are capital-intensive businesses requiring both equity and debt. Most struggle to raise either. According to a World Bank survey,50 37 percent of small power providers across four countries reported that access to finance was a severe or very severe business constraint, and 67 percent of small power providers rely on their own funds for investment. The entrepreneurs who set up Cambodia’s VEE invested $50,000 of their own equity to start their business, an amount that few entrepreneurs in developing countries would be able to match for a long-term investment in a rural area. The Korayé Kurumbu and Yeelen Kura RESCOs relied on support from Electricité de France, Total, and Malians living abroad to cover start-up costs.51 HPS is one of the few mini-grid companies to secure formal equity investment, but still it has mostly financed its capital and operating costs from grants and some equity from the owners. In 2008, HPS added three new power plants with $100,000 in winnings from business plan competitions and grant funding from the Shell Foundation. In 2009, operations were expanded to 19 power plants with $1.65 million raised from Draper Fisher Jurvetson, the Acumen Fund, LGT Philanthropy, and IFC. Other examples remain elusive. The ongoing success of mini-utilities will in large part be driven by the willingness of commercial banks to provide debt. Most large utilities are financed by at least 50 percent debt, and similar levels would probably make sense for more mature mini-grids, although few have managed to access commercial finance. Those that have borrowed have benefited. For example, DESI Power has a commercial loan from ICICI Bank, and VEE has debt from ANZ Bank. Their growth would have been constrained without this capital. Meanwhile, Husk Power continues to struggle to secure loans from local banks. Accessing concessional financing to help cover connection and other capital costs Subsidies can help mini-utilities cover connection and other capital costs and accelerate penetration into BOP areas by closing the “viability gap” (the shortfall between revenues that customers are able to contribute and those needed for enterprises to be financially workable). Mini-utilities serve marginally viable customers, are often located in hard-to-serve areas with logistical challenges, and tend not to operate at scale. Subsidies can help offset the cost of connection, significantly improving financial performance and allowing them to reach households in poorer areas than otherwise would be the case. HOW COMPANIES ARE SERVING THE MARKET 100 Businesses in other sectors have realized that removing high up-front costs will increase growth and profitability. In some countries, mobile phone companies routinely subsidize the handset purchased by consumers by spreading the cost over time through user charges. The handset is locked to a provider’s network, so the deal buys a customer relationship, too, and the provider profits for years to come. Cable TV firms, similarly, often connect customers for little or no charge in exchange for a multiyear contract. In the energy access space, there have been a number of approaches to reducing up-front costs of solar home systems. For mini-utilities, waiving the connection fee can increase the amount of capital required by as much as 30 percent, and this is an area where targeted subsidies are being effectively channeled. Even if the cost is spread over time, most mini-utilities cannot offer to connect customers for little or no up-front payment; they are simply unable to finance such large capital outlays on their own. Financial support for these connections from governments or development agencies can help. These are offered in countries such as Cambodia and Tanzania and are successfully attracting businesses to the mini-utilities space. While it is perhaps harder to ensure that they are appropriately applied—and not, for instance, used to keep an otherwise unviable business afloat—another approach involves subsidizing plants with very high capital costs. Rwanda’s REPRO closed its viability gap with grant funding. Of the (approximately) $350,000 needed to buy and rehabilitate the hydropower plant it acquired from a failed donor-sponsored project, 32 percent was financed from owners’ equity, 18 percent was borrowed commercially, and a grant from GIZ covered the remaining 50 percent. The grant increased return on equity from about 8 percent to above 16 percent, making it commercially attractive. Recognizing the role that they play in energy access, up to 80 percent of the capital costs of hydropower, solar PV, and hybrid mini-utilities in Mali are paid by the national rural electrification agency, AMADER, itself funded in large part by the World Bank. Also in Mali, but taking a novel approach to sources of funds, Electricité de France’s model has built on financial assistance from migrants living in France. As a “stakeholder” of unelectrified rural communities to which they still had family ties, the Malian Diaspora community has helped to cover the unviable portion of the Korayé Kurumbu and Yeelen Kura RESCO capital costs. Nigeria’s BUC effectively uses subsidies in the form of CSR funds and in-kind contributions from the oil and gas industry to cover its viability gap. The BUC project was created as a means of securing a local “license to operate” on Bonny Island. The Nigeria Liquefied Natural Gas operations of Shell and other joint-venture oil companies export natural gas from a strategic terminal on the island, bringing value to both the initiator and the recipients. However, the high capital costs associated with extending connections to households and businesses across the island, coupled with the policy of not recovering these costs in full from end users, means that grants are required to cover this particular part of the investment. BUC has almost achieved breakeven on operations and maintenance, and has plans to increase tariffs to allow it to turn cash flow positive by 2014. Given that it is providing a service that the community would otherwise likely not receive, public sector concessional funding of connection costs could be justified. 101 CHAPTER 3 Grid-based Electrification: Centralized Utility Approaches Given its importance for long-term economic progress, ensuring sufficient low-cost, reliable electricity is a government priority in both developing and industrialized countries. However, unlike household-level devices and mini-utilities, the opportunity for private companies operating on a purely commercial basis to make money from grid extension in low-income areas is fairly limited. Almost without exception, governments are involved in the sector, through regulation, finance, ownership, and subsidies. This is in part because, as a natural monopoly, electricity grids are generally highly regulated. In addition, since the business of adding generation capacity and extending connections for many miles into often remote areas (where the demand of poorer end users is low and thus revenues limited) is highly capital intensive, returns on investment are low. With capacity addition and connection costs being relatively expensive, grid supply is the least- cost option only when population density and per capita demand are reasonably high. Because financial incentives are often required to encourage private participation in grid extension, this section showcases a range of successful strategies adopted by both governments and companies, often working together in public-private partnerships (PPPs), in various parts of the world. While acknowledging the importance of policies and management of broader power sector reform issues (such as cost-reflective tariffs, availability of sufficient capital to maintain existing systems and add new infrastructure, and prudent management), we focus specifically on tactics that have helped extend grid access to the poor. Grid Extension: Business Models – How Companies are Serving the Market To achieve high levels of electrification in a short time, China, Morocco, South Africa, and Vietnam have relied largely on public-sector-led programs, but their operational approaches have varied. China’s electrification process, beginning in the 1950s, used a combination of centralized and local grids to achieve about 95 percent electrification. South Africa went from less that 35 percent electrification to over 80 percent between 1990 and 2007, largely leveraging a single state- owned utility to deliver connections, but complementing this with off-grid solar home systems delivered by private players. Morocco achieved 96 percent electrification through a combination of grid extension and off-grid solar home systems. It financed the former with a combination of end-user payments and local government subsidies, and direct investment by the utility that were recovered commercially. Vietnam jumped from 2.5 percent electrification in 1975 to about 97 percent in less than three decades. Its program involved generation by the national utility and local distribution cooperatives that retailed to communities as small as 1,000 people. In many other countries, service contracts supported by smart subsidies have been the basis for involving the private sector in grid-based electrification. Utilities operating in Chile and Guatemala, for instance, have made strides in electrification on the back of PPPs and output- based subsidies. Here, governments have auctioned off concession areas to private distribution companies, giving them specific targets to increase coverage and providing a direct payment for each connection made to cover the investment’s viability gap. On their own initiative, distribution companies in Brazil, India, and Uganda have focused on solving efficiency, distribution, and revenue issues linked to serving poorer customers. In these cases, utilities have made progress in reducing technical losses and theft in urban slums and are installing prepaid meters and other technologies. This improves service quality and reliability and, at the same time, enhances revenue recovery, which means that they can often extend access into unserved markets. HOW COMPANIES ARE SERVING THE MARKET 102 Figure 3.20 presents an overview of examples covered in this section. Many of these countries are vertically integrated, working across the grid-based electrification value chain, from generation, through transmission, to distribution and retail (figure 3.21). ONE-PPP, Morocco Vietnam North Delhi Electricity Jamaica Public Power Ltd, Service Company India MERALCO, Philippines CEPALCO, DOMLEC, Philippines Dominica COMASEL, Senegal CODENSA, Colombia CEMAR, UNELCO, Brazil Vanuatu ESKOM, South Africa FIGURE 3.20: Location of electrification entities profiled in this section Source: IFC analysis. Supply quality, Adding capacity Successful Prepaid meters Utilities are cost control, and requires bold utilities build on provide a uniquely placed process leadership, either industrial win-win for to provide improvement in the company customers and utility and finance for or in government limit losses customer connection costs and more Design / Sales & Billing / Consumer After Fuel R&D Generation Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance PPPs are a good Providing way to finance targeted and operate output-based extended-access subsidies can grids help utilities fill the viability gap FIGURE 3.21: Grid extension – how companies are serving the market Source: IFC analysis. 103 CHAPTER 3 R&D and Design Extending grid power to the poor requires technical innovation to reduce connection and infrastructure costs. Electricity utilities are not generally thought of as technical innovators. But the reality is that extending grid power to the poor requires many practical breakthroughs to reduce the planned cost per connection, and to minimize cost overruns over time. Morocco’s Global Rural Electrification Program (PERG) was started in 1996 by the incumbent utility, ONE, and targeted universal electrification by 2008. Following fairly slow progress on electrification undertaken in a previous public-sector-led national electrification effort, ONE looked at ways of innovating to keep the program on track financially and operationally. ONE began by undertaking a detailed mapping—using geographical information systems—of all unelectrified areas in the country. It developed an electrification master plan that specified which households in 40,000 villages could reasonably be connected to the grid, and which would need to be served using off- grid systems (for example, solar home systems and mini-hydro). Thereafter, it focused on lowering installation costs. For example, it cut about 30 percent of infrastructure costs by reducing the maximum height of poles, using post-mounted substations, and streamlining eligibility criteria for contracted construction companies. Several utilities around the world have leveraged technical innovation to improve efficiencies and to reduce commercial and technical distribution losses. The use of smart meters, in particular, has shown potential, as demonstrated by Ampla, the distribution company in Rio de Janeiro, Brazil. And while most of South African utility Eskom’s success can be attributed to the policy, institutional, planning, and financing issues discussed below, innovation also played an important role in its activities. Charged with delivering on a government decree to achieve universal electrification, but facing financial constraints, Eskom had to think creatively about how to viably extend its grid. Initially it focused on supply-side, quality-driven technology optimization through, for example, research into the impact of lightning strikes on overhead distribution lines. Later it saved money by adopting technology more suited to typical customers, including prepaid electricity meters and single phase lines, which significantly reduced capital costs. Improved processes played a role, too, including greater use of decision-making tools, adoption of new financial evaluation methods, computer-based asset management, and software for feeder design. Generation Sufficient generation capacity is a critical prerequisite for extending the grid to unserved areas in such a way as to truly increase access to reliable electricity; however, this can be a challenge for many developing countries. In Vietnam, for example, the government coupled its resource blessings (large hydro potential and coal) with a determination to build generation capacity that could—and did—reach the whole nation. In Sri Lanka, renewable energy feed-in-tariffs encouraged small grid-connected hydropower development. But many countries do not have sufficient power plant capacity to serve currently connected populations, let alone new ones that might be connected. Any capacity added to the network would likely be consumed by existing customers that require more electricity than is currently available, leading to a situation where newly connected customers receive “rationed,” unreliable power. More often than not, there is little incentive to add new capacity to the system. In countries where the utility lacks capital to install new capacity, there are usually other systemic issues. HOW COMPANIES ARE SERVING THE MARKET 104 These generally stem from the inability of the utility to recover connections. Policymakers can play an important role here costs. This might be due to weak transmission and distribution by helping these companies improve their revenues. Setting infrastructure that leads to high technical losses and a distribution companies on a sound footing by helping to corresponding decline in revenues. Equally, it could be due to improve their collection rates ensures that electricity retailers commercial losses, where the utility cannot recover the cost of are in a position to recover the cost of power purchased from power consumed from customers for various reasons—both generators, and that these generators get paid for the power they political and practical. Whatever the reason, this undermines sell, so are incentivized to build. In many countries, this is a the ability of the utility to finance new generation capacity. The highly political issue, since few governments want to be seen problem is particularly pronounced in countries with a vertically to encourage a “pay-or-disconnect” policy. But there are some integrated monopoly, where a (mostly) state-owned company is successes. responsible for generation, transmission, and distribution, with Eskom’s ability to add generation capacity, for instance (while limited transparency into the overall system. But liberalized certainly made easier by access to local low-cost coal, skills, and systems, where generation is split from distribution, are not capital) was considerably helped by an independent leadership immune to capacity challenges. In these instances, firms on in the 1980s and 1990s that managed to free itself enough the generation side often have reduced incentive to invest in from government influence to chart its own course.52 Another capacity due to high credit risks associated with electricity approach is to use power purchase agreements, often backed offtakers (typically distribution companies that cannot collect by government guarantees, to encourage capacity additions. the revenues they are due). While not without its issues, notably a significant potential Both South Africa and Vietnam built their grid extension burden on public finances, especially if other fundamental plans on the back of solid industrial use, and in both cases it market and sector reform issues are not resolved, this approach was central to their success. South Africa has a very energy- has been successful in attracting significant new generation intensive economy, primarily driven by the manufacturing infrastructure in India, Kenya, Mexico, and Thailand. and mining sectors. This provided sufficient long-term sales revenue to finance investments to improve energy systems and to cross-subsidize rural access. Vietnam’s government was Transmission, Distribution, and Sales determined to provide rural access. But it first built capacity for On the transmission and distribution side, system losses, through its rice production sector, where the provision of grid electricity power theft or nonpayment, and technical inefficiencies, can increased revenues for rice producers. This fueled growth of be as high as 40 percent in some countries and have become the rice sector, creating more customers and in turn helping a significant barrier to the extension of service into unserved to finance grid extension. The result was a double win since areas. Ironically, dealing with the problem blocks access in the Vietnam is today the world’s second-largest rice producer and short term (when nonpaying consumers are cut off) but is vital has nearly universal electricity access. Industrial customers to long-term extension of access because high losses prevent offer relatively reliable cash flows from power sales, especially investments in power generation and grid infrastructure. in sectors where the returns to investments in electrification are particularly high. Using these customers to cross-subsidize To tackle the problem of commercial losses in the distribution lower-income consumers appears to be one of the most practical system, a mix of technical, business model, and corporate social and effective tactics used to extend electricity access. responsibility ideas have been employed. The Jamaica Public Service Company (JPSCo), for instance, has been adapting So, while we see limited activity in the generation designed ideas from Brazil to stop power theft in low-income areas in expressly to improve energy access for the poor, it is clear inner-city Kingston by using insulated connections to homes that improving electrification requires both state utilities and to prevent the traditional method of throwing another line over independent power producers to add capacity to meet current the noninsulated connection and drawing power illegally. and future system needs, including load growth from new 105 CHAPTER 3 The company has also introduced remotely readable meters, which are connected wirelessly to a screen inside the house for the household to keep track of its consumption. In addition, meters and connections for a group of households are in a single pole-mounted enclosure that shuts down entirely if interfered with. This prevents tampering—often through social pressure. The utility also runs a community campaign that includes information sessions, public education, and the establishment of neighborhood offices to make it easier for residents to sign up for legal connections and access qualified assistance for legally rewiring their homes (see box 3.11). Similar approaches have also helped Ampla in Brazil to reduce losses, by double-digit percentages in some cases.53 India’s North Delhi Power Limited faced similar problems when it was formed, and invested in regularizing customers through a consumer group dedicated to serving families in very low- income areas. To manage losses, North Delhi Power Limited’s (NDPL’s) “Special Consumer Group” works with communities to raise awareness about the need to connect to the power system legally, build legitimacy, and make bill payment easier. To increase ability to pay among these communities, NDPL, which is 51 percent owned by the Tata Group, has also developed a limited number of vocational training courses to help increase customers’ income, and offers basic life insurance as an incentive to families that keep up with bill payment.54 Realizing the value of such payment incentives, Eletropaulo in Brazil offers analogous services, such as free Internet access in sponsored community centers to customers who pay their bills on time. Type of illegal and unsafe connections that plagued a Brazilian utility before their successful intervention to prevent theft (Credit: Hans de Keulenaer) HOW COMPANIES ARE SERVING THE MARKET 106 Box 3.11: Case studies on reduction of nontechnical losses – JPSCo and RAMI Jamaica’s sole vertically integrated utility, Jamaica Public Service Company (JPSCo), serves approximately 582,000 customers across the island nation. Since privatization in 2001, JPSCo has struggled with persistent and growing electricity losses. Beginning in 2002, metered residential consumption began to decline as nontechnical (commercial) losses rose steadily, indicating a widening problem of illegal connections. By the end of 2009, total system losses were almost 24 percent. More than half were attributable to electricity theft. To tackle theft of power, JPSCo has been creative in using both internal expertise and international best practice to develop an electricity loss reduction program that both deters power stealing and addresses the culture of nonpayment that has flourished in low-income areas like inner-city Kingston. With a newly organized loss control department staffed by almost 300 employees, the company began to focus on residential customers in the identified “Red Zone” areas where losses were above 30 percent of electricity supplied. These communities and informal settlements accounted for an estimated 85 percent of total nontechnical losses. The program that developed was named the Residential Advanced Meter Infrastructure (RAMI). RAMI projects are composed of an integrated package of outreach and technical offerings for local communities, including consensus building among various local stakeholders, maintaining a local presence at work sites, and sponsoring outreach campaigns to raise customer awareness and provide education about electricity bills and consumption. The utility also runs a community campaign together with the government. This includes information sessions, education through churches and schools, and the establishment of neighborhood satellite offices to encourage residents to sign up for legal connections. Residents who volunteer to have their houses safely and legally rewired are eligible for financial assistance, including a four-year interest-free loan from JPSCo. Once consumers are regularized, billing at full cost is gradually introduced. During the first month, residential bills are 100 percent subsidized to allow the customers to evaluate their electricity use. Subsidies are gradually removed over several months. As consumers become customers, outreach workers go door to door to answer billing questions and educate communities about efficiency options. In addition, JPSCo targets illegal connections through a variety of technical strategies, including automated metering, theft-resistant distribution networks, ongoing customer audits, and effective maintenance and controls. In some pilot neighborhoods, meters and connections for a group of households are put in a single pole-mounted enclosure that is programmed to shut off entirely if the enclosure is breached. This has been successful at preventing tampering, a problem often exacerbated by social pressure. While still in the early stages, JPSCo reports that the program is succeeding both in returning lost revenue and increasing its legal consumer base. Despite challenges and barriers to implementing the RAMI programs, the company estimates that the investment return from Red Zone interventions can be over 200 percent. 107 CHAPTER 3 Companies in other grid-connected sectors including water and communications have also offered incentives to reduce theft and nonpayment. Manila Water, a successful private water utility, implemented a “Full Circle Approach,” which sought to expand micro-businesses by including them in its own supply chain, supplementing residents’ income, and helping them pay their monthly bills. Some mobile operators are looking into ways to provide some degree of community service and free cell phone charging (which also increases revenues to the operator from increased cell phone uptake and, thus, talk time) in remote areas. These include MTN and Airtel operating charging kiosks in Kenya and Uganda, respectively; rooftop solar-based power provided by Orange for a clinic in Niger; China Mobile with a mini-grid operation in Sichuan province; and several Safaricom sites across Kenya, providing street lighting, power for community centers, and mobile charging. Such approaches are often designed to help engender a sense of ownership, so that the community takes responsibility for protecting infrastructure, such as meters, water connections, and telecom base stations.55 Focusing on the more complex issue of land tenure in the Indian state of Gujarat, the Ahmedabad Electricity Company Limited has experimented with formalizing household titles as a means of increasing slum electrification. Working together with the Ahmedabad Municipal Corporation, the Gujarat Mahila Housing Trust, and other public sector partners, the Ahmedabad Electricity Company Limited (AEC) introduced subsidized connections, funded in part by USAID and AEC but with a significant payment from the end user. This, together with the issuing of a noneviction certificate to each household for a period of 10 years by the Ahmedabad Municipal Corporation, provided them with both the basis on which to secure a connection and a financial incentive to do so. Local NGO partners mobilized the community, building trust and raising capital for the grid extension effort. During its pilot phase from 2001 to 2004, the project connected about 700 households. It has since scaled-up significantly, without public support, and has successfully electrified about 700 slums, reaching over 200,000 households.56 Billing and Payments Nonpayment of electricity bills is an important concern for many companies in the energy access space, mainly due to the low and volatile incomes of poor families. It is not that people do not want to pay; rather, poor families have difficulty saving up enough cash to mirror the monthly or quarterly billing cycles typical of utilities. The challenge of lump-sum payments is demonstrated by the continuing popularity of kerosene for lighting (a more expensive, less efficient, and highly polluting fuel) in grid-connected low-income households, since kerosene can be bought in small volumes, allowing people to manage their energy expenditure more easily.57 The outcome is a no-win situation, because when families sign up for grid power but then fall quickly into arrears, utilities are discouraged from serving poor areas. Meanwhile, those same households may face disconnection, and are further penalized by additional charges (disconnection, reconnection fees) and a long wait for service to be restored, so they in turn begin to resent the utilities and may turn to expensive informal suppliers. HOW COMPANIES ARE SERVING THE MARKET 108 Utilities such as Dominica Electricity Services Limited (DOMLEC) and Umeme, a privately owned Ugandan electricity distributor (and IFC investee), are solving these problems with prepayment meters. Like prepayment for mobile phones, the customer buys widely available tokens, each with a unique code. The code is entered into the meter to credit the account and supply power. When credits run out, the account is not disconnected, but the electricity ceases, to be started again when the customer again has cash available. When prepaid meters are introduced in areas previously served by traditional meters, this can be politically difficult for utilities. Thus, such programs are mostly complemented with public education campaigns that explain the relationship between nonpayment and weak electricity service, and demonstrate a clear link between the introduction of prepaid meters and improved service, and grid extension. DOMLEC, a private company,58 has used prepayment meters to cut billing costs and reduce average collection days, and is planning a full rollout. The company introduced the system after rising fuel prices pushed up the cost of electricity, with a subsequent increase in nonpayment of bills and a hit to the company’s cash flow. The new meters display not only the amount of electricity used, but also how many kilowatt hours a consumer has remaining in the account. This information is easy to read and helps households plan and budget their electricity use. The utility reports that the system has been popular with customers because it prevents disconnection and reconnection fees. In addition, DOMLEC spends less trying to collect on defaulted accounts and saves on billing and administrative costs. Midway through the full rollout of the new meters, average collection days had dropped 40 percent. The company now plans to expand the program with full rollout during 2012. Umeme has also been piloting prepaid meters for its operations, and plans to spend $100 million installing them across the country. The utility cites the same advantages as DOMLEC, in particular lower administrative and bad debt costs. Ahmedabad Electricity Company has used strategically placed bill collection units and collection vans to improve its billing system. Slum households receive monthly bills—as opposed to bimonthly invoices issued to other customers—while collection relies on a combination of strategically placed bill collection units, located in community organization offices, civic centers, post offices, gas agency offices, and mobile collection vans. Consumer Financing New approaches to consumer financing are also emerging, particularly around connection fees. Traditionally, utilities charge customers for new connections, and these up-front charges can often be prohibitive for poor consumers. Many families could in theory afford a monthly power bill commensurate with their current spending on fuel, but not a large up-front connection fee, which can easily run in the hundreds of dollars, even in urban areas. A number of utilities around the world have broken with the traditional practice of connection charges in order to increase their customer base and, consequently, boost access. 109 CHAPTER 3 Philippines-based Cagayan Electric Power and Light Company Codensa Hogar was successful because a utility is in a unique (CEPALCO) illustrates that waiving the connection fee can position to overcome the challenges of delivering finance to work. CEPALCO is an electricity distribution utility serving low-income markets. The utility already has infrastructure the City of Cagayan de Oro—a small town in the Mindanao for sending bills, and the incremental cost of adding other region of the Philippines—and the surrounding municipalities. financial transactions is low. This is not dissimilar from the It makes it easy for new customers to connect by waiving the up- approach taken in the device segment of the market, where front connection fee and asking for a deposit on the first month’s the distribution channel itself has become an asset for many bill before recovering the cost of connection through the sales companies. Cookstove players with strong distribution of power to all connected customers. CEPALCO has grown networks are starting to cross-sell lanterns, and vice versa, and strongly, from serving 750 customers when it was founded in microfinance institutions are used as a means for selling energy 1952, to a base of 100,000 customers in 2012. It now serves products to borrowers. In this case, Codensa has a database of 96 percent of the households in its franchise area.59 Of course, information relevant for credit-scoring, including repayment not charging for the connection increases the amount of capital records. The question is how this asset can be used; knowing invested in the company. However, provided the investment where the customer lives, and being able to cut off power in the is earning a return, in this case through enabling faster event of nonpayment, makes enforcement easier.61 connection growth, this need not be a problem. CEPALCO has always been able to attract private equity and debt finance sufficient to meet the company’s growing needs because of its Corporate Finance overall performance, including consistent profitability. PPPs involving public financing that subsidizes private Codensa Hogar in Colombia has shown not only that power investment have a good track record in extending the grid, connecting customers at a higher rate than national utilities. distribution companies can successfully provide finance to For example, North Delhi Power Limited (NDPL) was born low-income customers, but that this ability may actually from the privatization of Delhi’s power distribution company. represent a valuable hidden asset. Colombia’s Codensa, the The local government wanted to lessen subsidy spending and private utility supplying the capital Bogotá,60 leveraged its improve service quality by reducing system losses.62 Crucially consumer information and utility bill payment track records to for access extension, privatization was accompanied by create a separate financing arm—Codensa Hogar—to provide subsidies and regulation reform. Distribution operations were customers with consumer financing. Codensa Hogar offers divided into three companies, each covering part of the service credit cards to Codensa customers, 60 percent of whom have territory, and bids were sought from private firms that would no bank account and 35 percent of whom live on $2 or less acquire 51 percent of the shares in each company, and operate per person per day. Codensa Hogar’s clients mostly use their and control the company. The government subsidized the price new credit lines for purchasing electrical appliances, which of of bulk power for five years to give the private companies time course spurs demand for power. Indeed, the consumer credit to turn around the loss-making operations, without leading to business line quickly became more profitable than Codensa’s massive rate increases that would have led to a public outcry. core business, generating 7 percent of company revenue and 9 NDPL was the joint venture formed between Tata and the percent of its earnings before interest, taxes, depreciation, and government to manage one of the areas. Since its formation in amortization in 2008. In 2009, Codensa sold the business for 2002, NDPL has almost doubled connections to 1.2 million, $290 million to Multibanca Colpatria, which now provides the much of this through grid extension, and has regularized balance sheet to finance the further expansion of the business, connections in slum areas. Importantly, since privatization, it while the company retains the role of marketing to its customers has also been able to attract financing. Total capital investment and collecting payments from them. in the company since 2003 is over $610 million.63 HOW COMPANIES ARE SERVING THE MARKET 110 Guatemala’s rural electrification concessions have succeeded in The Government of Senegal has also opted for a concession extending access by combining a well thought out package of contract approach rather than privatization to extend grid sector reforms, private management and finance of the utility, supply through its Senegal Rural Electrification Concessions a concession contract, and output-based subsidies for new program. In 2004, it divided the unserved parts of the country connections. In 1999, Guatemala privatized its rural power into 10 rural electrification zones then bid out contracts over distribution companies through a concession, which was won time. Contractors have to meet connection quotas, which by Spanish utility Union Fenosa Internacional. The contract require that they build, finance, operate, and maintain a required Union Fenosa to connect at zero cost all customers new rural distribution utility. The government subsidizes in the area who wanted service, provided they were within capital costs per new connection, given that much of the area 200 meters of the existing distribution grid. The government cannot be served commercially. By covering the viability gap then established the Rural Electrification Program to extend inherent in grid-based electrification for poor communities, the the distribution network to 2,633 communities beyond the subsidy has attracted private capital to the table, including an 200-meter limit, by providing an Output-Based Aid subsidy investment of $400,000 by IFC. This use of Output-Based Aid, of $650 per connection. This payment funded the rollout combined with competitive tenders, should yield the maximum of the network to unserved communities and encouraged extension of access for any given level of public funding.66 the company to deliver on policy goals. The combination of The concession contract design is technology-neutral, which privatization with the incentive-based connection subsidies allows the concessionaire to decide which mix of technologies in the rural power sector has led to a more than doubling of makes best commercial sense in which areas, and also provides connections to 810,000 within 10 years. The company is also for certain off-grid targets to be met, for example, with solar profitable: in 2009 it reported earnings before income, tax, home systems. The first concession was awarded to ONE, depreciation, and amortization of $45.5 million.64 the Moroccan utility, in 2007/08, and covers 15 percent of Senegal.67 It will be contractually bound to provide over 19,000 In Chile, a concession-based PPP was used to attract private connections—13,000 grid connections, and 6,000 solar home sector investment to electrify about 240,000 unserved systems. Thirty-five percent of the capital costs will be provided households, primarily through grid extension. In the mid- by a government grant. 1990s, about 50 percent of Chile’s rural population was electrified compared with 97 percent in urban centers. The government established an electrification fund designed to provide a one-time payment or viability gap subsidy on the capital costs of private companies connecting rural customers to the network. No subsidies were offered to cover operational costs. Competition was encouraged by requiring companies to propose electrification projects to regional governments, which allocated financing to the operator largely based on the lowest cost to serve. Regional governments, in turn, would receive a fiscal allocation from the central government based on their connection rate, so were incentivized to select high-performing companies to deliver services.65 The Government of Chile’s program was in part funded through concessional loans from the World Bank and the Inter-American Development Bank. Over the decade that it was operational, the program achieved almost universal rural electrification, and is considered a good example of subsidy allocation. 111 CHAPTER 3 Grid Extension: Key Success Factors in the Business Model To extend access to electricity in a commercially viable manner, companies must be creative with their business models. In addition to the basics of long-term capital, skilled and motivated staff, reliable sources of low-cost primary energy, and modern management systems, the business model must have the following three additional factors, which are key to the successful operation of companies extending the grid into low-income areas: • Public-private partnerships, which have proven to be highly effective • Management of payment risk and prevention of theft • Provision of flexible payment terms to customers (see figure 3.22). Design / Sales & Billing / Consumer After Fuel R&D Production Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance Public private Managing Providing partnership payment risk and customers with model for theft flexible payment financing and terms delivery FIGURE 3.22: Key success factors in the grid extension business model Source: IFC analysis. Public-private partnerships, which have proven to be highly effective Almost all examples of grid-based electrification business models have involved a PPP with some degree of capital subsidy to attract private investment. Governments have most often awarded contracts with legally binding coverage targets and quality-of-service requirements. This sometimes comes with public financing to help cover the cost of such obligations. This subsidy is most often allocated on the basis of the lowest-cost but highest-quality service offering, and is applied to cover the viability gap on capital but not operating costs. Fundamentally, the design of the PPP, combined, of course, with other ecosystem success factors, should be viewed as a key operating success factor for most grid extension businesses. At their best, PPPs combine the finance and management capacity of private capital with carefully designed subsidies, regulations, and contracts to ensure that public objectives are achieved. A rigorous 2009 study looked at data on 250 electricity companies across 50 countries.68 The study found that utilities that had been privatized, or which operate under PPPs, extended access more rapidly than publicly owned utilities. The biggest increase in access occurred among public companies privatized through concession contracts. These companies increased residential connections at a rate 21 percent higher than their publicly owned counterparts. The NDPL example above is a good illustration of this. HOW COMPANIES ARE SERVING THE MARKET 112 Management of payment risk and prevention of theft Because weak revenues are the biggest deterrent to investments along the grid extension value chain, companies need to reduce power theft and improve collection rates to maximize viability. This may be done by using smart technologies such as prepaid meters. However, companies should also build a social contract with communities to encourage legal connections. Leveraging CSR programs to encourage willingness to pay within a community can help—especially when they offer services that customers value, such as Internet facilities or life insurance, as has been the case with NDPL. Some firms have succeeded in developing more symbiotic relationships in their BOP service areas by explaining the link between theft and higher rates or frequent power outages (for technical and financial reasons), and the impact of losses on grid expansion. “Utilities that have been privatized, or which operate under public-private partnerships, extend access more rapidly than publicly owned utilities.” Provision of flexible payment terms to customers It is crucial that firms find ways to help poor customers keep up with electricity consumption bills when income is low and volatile. Prepayment meters can help to expand access by cutting administrative costs and bad debts, thus enhancing profitability. And by making payment easier for customers, reducing the risk and cost of disconnection, they have an additional benefit of encouraging demand. As utilities adopt prepayment meters, opportunities to innovate further are likely to grow. For example, electricity companies could partner with phone companies to accept their scratch cards. This has the potential to further reduce costs and increase the convenience of the prepayment system. The meters could be enabled for mobile phone communications, allowing families and friends to pay an electricity bill by sending an SMS message transferring credit, as is commonly done between mobile phone accounts in developing countries. This could increase sales for the utility and also increase energy access, because better-off relatives would be able to cheaply and remotely pay the electricity bill of relatives in rural areas. Perhaps electricity will start to be sold as part of a “quintuple play” along with mobile, fi xed wireless, broadband Internet, and pay TV by companies that are already bundling the other four services, like Dialog in Sri Lanka. Or maybe electricity companies will start selling “microcredits,” for as little as U$0.25 worth of power at a time, like Idea Cellular has done with mobile talk time to drive its penetration of the rural telephony market in India.69 Smart metering could even be used to offer special “low-price power deals” to poor users when there is excess capacity, or to give low-income customers additional credit for reducing their demand during peak times when power cuts might otherwise be a risk. 113 CHAPTER 3 ABOVE: A STREET IN HAMMANSKRAAL, SOUTH AFRICA, WHERE 85 PERCENT OF HOUSEHOLDS HAVE BEEN ELECTRIFIED BY GRID EXTENSION (CREDIT: TERRESTRIAL) HOW COMPANIES ARE SERVING THE MARKET 114 Grid Extension: Key Success Factors in the Ecosystem Environment The right ecosystem environment is even more crucial for successful grid extension than for devices or mini-utilities, given the key role of policymakers in ownership, subsidies, and regulation. In many countries, regulatory barriers can prevent private utilities from reaching unserved areas, while enabling regulatory conditions are needed for public-private partnerships to flourish. The key success factors for ecosystem conditions are, therefore: • Removing regulatory limits on service areas • Allowing flexibility in tariff regulation • Removing restrictions on supplying informal settlements • Financing the connection of the end user, including through smart subsidies (see figure 3.23). Design / Sales & Billing / Consumer After Fuel R&D Generation Marketing Distribution Payment Finance Sales VALUE CHAIN OF BUSINESS ECOSYSTEM CONDITIONS Legal & Regulatory Corporate Finance Subsidies Carbon Finance Removing limits Removing Flexibility in Smart design of Finance the on service areas restrictions on tariff regulation electrification connection of supplying and universal subsidies the end customer informal service funds settlements FIGURE 3.23: Key success factors in the grid extension ecosystem environment Source: IFC analysis. Removing regulatory limits on service areas Removing expansion limits for utilities can be an important factor in extending the grid. In the Pacific Island country of Vanuatu, for example, UNELCO, a subsidiary of France’s GDF-Suez, provides power in just four locations throughout the archipelago.70 Within its concession areas, the electrification rate is nearly 100 percent, while outside it is just 7 percent. The areas outside the concession are uneconomic to serve—the terrain is mountainous, the population dispersed, and incomes low. But even if it wanted to, it is actually illegal for UNELCO to provide service outside very small, defined districts. As the economy grows, more people and businesses are seeking power and are able to pay for it—a number of them located outside the area the company is permitted to serve. It is difficult to fathom why the only professional power provider in the country should be legally prohibited from meeting this demand—especially when the government has no other comprehensive or operational plan to provide service outside the concession areas. 115 CHAPTER 3 Another option is to allow concessions to provide a monopoly for grid power, but then to open up competition in the off-grid and mini-grid power supply. From the outset, Vietnam followed this path, allowing mini-hydro systems to operate in hard-to-reach areas, even if these were technically part of a concession but not being served by the grid. Later, when the grid reached them, these previously isolated systems connected to it or, alternatively, stopped operating. Today, over 50,000 households are still electrified by such installations. This scenario can also be observed in the Philippines and in a handful of other countries.71 Governments have been removing regulatory restrictions on mini-utilities. Logically, then, they could advance access by also allowing utilities that want to extend their grids outside their defined service areas to do so, where appropriate, with a minimum of regulatory hassle. Removing restrictions on supplying informal settlements Restrictions on supplying informal settlements in developing countries also hinder the extension of energy access. To discourage squatting, utilities are often banned from serving people living in slum areas and urban peripheries because dwellers do not have legal titles to the land. In areas as diverse as Jamaica and the Indian National Capital Territory of Delhi, governments have managed to decouple utility supply from land title through simple legal changes. This has not been without debate, of course, but in both cases new rules make clear that the utility is allowed to supply any willing customer in the service area, and that legal supply of power does nothing to confer land title or government authorization of the dwelling. As a result, privately owned utilities such as JPSCo and NDPL have been able to profitably supply slums and urban peripheries legally, as have others such as the Ahmedabad Electricity Company. These initiatives have been highly successful and could be replicated by policymakers in other countries that limit informal settlement supply. Such models provide residents with access to a formal power connection while also allowing the utilities to cut down on the theft of power by regularizing illegal connections. Allowing flexibility in tariff regulation Regulators should be allowed to set different tariffs for different areas, based on the cost of delivery, so that utilities can charge rates that make it commercially viable for them to extend the grid. Governments and regulatory bodies frequently set caps on tariffs that make it unprofitable for utilities to serve poor customers, especially those in rural areas where cost of service is typically higher. Although clearly intending to make power affordable for poor customers, this can in fact have the opposite effect, stopping utilities from extending access and thus forcing the poor to rely on even more expensive and problematic household fuels or illegal suppliers. One alternative is for regulators to set different tariffs for different areas, based on the cost of delivery. This approach is not dissimilar to the feed-in tariffs designed to attract renewable energy, which is often more expensive than conventional generation, into the supply mix. HOW COMPANIES ARE SERVING THE MARKET 116 There are other instances where tariff regimes fail to incentivize reductions in transmission and distribution losses—say, when any loss reduction is directly passed through to consumers through rate reductions. Instead of a full pass-through, regulators could incentivize loss reductions by progressively assuming linear loss reductions over time, thus forcing the utility to reduce losses by the assumed amount. This would permit the utility to maintain profitability, while allowing companies to reap the benefits of any additional loss reductions above the “assumed rate” until the next tariff cycle. Finally, policymakers could adapt the concept of a universal service fund from the telecommunications sector. Under this approach, a government plan levies a charge on customers in urban areas, to create a fund to subsidize service in rural areas that are more expensive to serve. The subsidies cover the difference between the rural tariff and the true cost of supply to a level where poorer areas are profitable to serve. The Philippines has done exactly this with its Missionary Electrification Fund. Colombia does something similar to keep down tariffs charged by mini-utilities in the noninterconnected zone of the country. The same concept could easily be extended to the supply of power involving grid extension to a rural area, and should be considered as an alternative to straightforward tariff regulation. Financing the connection of the end user, including through smart subsidies Grid utilities, like mini-utilities, should find a way to finance the up-front costs of connections. As noted throughout this report, credit supply is often a key factor for success in inclusive businesses across sectors. A majority of the 14 companies reviewed in a 2010 IFC publication on the base of the pyramid either provided consumer finance themselves, or partnered with another organization that did.72 Subsidies can sometimes help utilities cover connection costs, enabling grid extension into very poor areas. This need not always be the case—for instance, AEC in India and CEPALCO in the Philippines were able to extend access to slum areas without public funds. But in other instances, particularly when governments are determined to extend access to zones where customers are not willing and able to pay the full commercial cost of service, then much more public policy and financial support is needed to incentivize companies to enter the market. Well-designed public financing policies ideally combine the best of private finance and management with a subsidy that fills the viability gap and allows grid extensions into areas that would otherwise be uneconomic to serve. This can either be achieved through a PPP, as in Guatemala, Morocco, and Senegal, where concession contracts place legally binding coverage and service targets on the company involved, and provide output-based subsidies, or subsidies can be provided to private utilities, as in Brazil. There, the governments sought to maximize the access achieved per dollar of public funding through a program called Luz para Todos, which provides capital subsidies to help fill the viability gap. CEMAR, the private utility serving the Brazilian State of Maranhão— one of the poorest in the country with 6.2 million inhabitants earning a per capita income 29 percent below the national average—was able to take advantage of this program and succeeded in extending access by 50 percent to the poor.73 117 CHAPTER 4 Chapter 4: What Can Be Done to Help Scale Up Energy Access Success Stories? ABOVE: A BOY PLAYING AT DUSK WITH A SOLAR-CHARGED HEADLAMP (CREDIT: IFC) WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 118 There are vast underexploited opportunities for the private sector to provide commercial basic energy services to the poor (see figure 4.1), but the market remains complex and requires a pioneering spirit. The cases described in this report show what is working for some of these early movers and why they are succeeding. There are a variety of key success factors that emerge from this analysis. In the aggregate, they show that where strong business fundamentals and supportive ecosystem conditions converge, enterprise-based interventions have generally done well. And, yet, the challenge of how to provide energy and also satisfy a profit motive has not been solved. It will take more effort to see the scaling and replication of today’s success stories across the world, and to encourage further innovation. Unelectrified population (millions) 98.6 100.0 98.8 100% 1,600 99.8 93.9 99.5 89.5 78.0 93.4 Electrification rate 1,200 796 68.9 74.0 72.2 68.8 1442 800 41.9 587 400 25.0 31 22 0% 9 0 Asia Africa Latin Middle Transition W orld Asia Africa Latin Middle Transition America East economies America East economies and OECD and OECD countries countries Overall Urban Rural FIGURE 4.1: Regional electrification rates and regional electricity access show the scale of the commercial opportunity in providing new energy access solutions Sources: IFC analysis; IEA. Note: OECD = Organisation for Economic Co-operation and Development. This report proposes focused intervention on the part of both public and private sector stakeholders, and discusses three specific angles: • Business models: Challenges for operating companies • Policy: Roles for governments and their development partners • Financing: Opportunities for impact and commercial investors. Figure 4.2 summarizes the report’s recommendations, which are discussed in detail in the following sections. 119 CHAPTER 4 Extending energy access to unserved communities has a huge impact on human development, but it is often seen as a development imperative. This report shows that it is also a $37 billion market that many companies are already serving RTQƂVCDN[ 6JGTG CTG VJTGG OCKP QRRQTVWPKVKGU KP VJG OCTMGV JQWUGJQNF FGXKEGU OKPKWVKNKVKGU CPF ITKF GZVGPUKQP Below are the key success factors that the most successful companies are demonstrating. This graphic shows which stakeholders have a role to play in each set of success factors. Household-Level Devices Mini-Utilities Grid Extension $GPGƂV Clean cooking & lighting Lighting and more Electricity Imperative Basic needs Productive uses Modern societal development Opportunity $31 billion $4 billion $2 billion Key Success Factors 1. Make products affordable by 2TQXKFGƃGZKDNGRC[OGPV 2TQXKFGƃGZKDNGRC[OGPV in the Operating innovative design of product and terms to spread connection costs terms for connection costs Model business model $WKNFQTVCRNQECNOWNVK 5GEWTGTGNKCDNGNQYEQUV 2. Secure business model with product distribution networks primary energy (fuel or feedstock) some degree of public support Challenges Challenges for operating for operating 3. Strengthen consumer 3. Design adequate population 3. Manage payment risk and companies companies EQPƂFGPEGKPGPGTI[FGXKEGU density and load factor theft a. Make the energy device or service affordable 4. Focus on replicability and entrepreneurs with technical b. Get the basics of operation right expertise and business acumen to scale operations c. Play to the strengths of the company Key Success Factors 1. Create quality standards and 5GVOKPKWVKNKVKGUVCTKHHUCV 1. Remove limits on service in the Ecosystem p provide information on products commercially viable rates areas Conditions 2. Build technology awareness in 2. Develop policies to encourage 2. Remove restrictions on the market OKPKWVKNKVKGU supplying informal settlements 3. Remove discriminatory taxes 3. Remove onerous licensing and #NNQYHQTƃGZKDKNKV[KPVCTKHH and duties across energy permit barriers regulation and universal service products funds (CEKNKVCVGEQPUWOGTƂPCPEG 4. Provide concessional &GUKIPUOCTVGNGEVTKƂECVKQP particularly for solar home ƂPCPEKPIVQEQXGT subsidies systems connection costs 5. Finance the carbon credit 2TQXKFGNQPIVGTOFGDVCPF Roles for process GSWKV[VQUWRRQTVUVCTVWRCPF governments and growth their development partners 6. Finance company growth and operations from an early stage a. Create the right ecosystem conditions 7. Train and support local b. Establish an independent entrepreneurs and industry entity to advance contributors Opportunities for impact the access objectives a. Provide appropriate funding for and commercial investors each part of the business life cycle c. Resist giveaway d. Support enterprise programs and b. Establish deal marketplaces development and business unrealistic promises and local presence to discover OQFGNTGƂPGOGPV hidden gems d. Decide which e. Fund delivery entities, and support solutions are the best c. Keep investment mandates broad the provision of resource and market ƂVHQTVJGCEEGUUIQCNU and beyond a single technology data, consumer awareness, and standards FIGURE 4.2: Summary of key success factors and recommendations Source: IFC analysis. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 120 Refining Business Models: story about potential development impact; rarely is the latter sufficient for consistently attracting capital, even from impact Challenges for Operating Companies investors. Hence, fundamental to securing financing is that the High sales volumes are essential in low-income consumer commercial business plan be well thought through, and, fairly markets, and companies must strive to achieve scale. This is soon after they get going, firms think about professionalizing true because, even though many of these products and services their management teams to take the business forward and help sell at high margins, the revenue per item is low. The examples it grow sustainably. in this report show that scale is possible in these markets and Meanwhile, larger companies must ensure that ventures into that entrepreneurs can achieve this by: the energy access market, which often start as relatively small • Making the energy device or service affordable initiatives below the top management radar screen, have good visibility within the company—as a CEO-sponsored effort, for • Playing to the strengths of the company example—and use this platform to leverage core competencies • Getting the basics of operation right. from around the business. The initiative may be incubated in the corporate social responsibility (CSR) department or another “soft start” area of the firm, but it cannot be allowed Making the energy device or service to remain there. After due time is allowed for the creation of affordable an innovative model to serve target markets, it must be treated Affordability is a consistent theme in this report and is largely fully commercially. Lessons can be drawn from the Bonny achieved through business model and device innovation Utility Company’s experience in moving from CSR to business together with the provision of consumer finance either directly (see box 3.8). or indirectly. Other strategies include rental models for devices, fi xed-fee/fi xed service mini-grids, and prepaid meters for grid Getting the basics right: Devices companies electrification. Companies should concentrate on as many must focus on mastering distribution of these as are relevant to their circumstances, especially in conjunction with the two recommendations below, to create Distribution has emerged as the major determiner of commercial an operating model that allows products to match customers’ success in selling modern energy solutions to underserved available funds. households, and this report has discussed in detail the need for companies to master this challenge either by building their own channels or by leveraging those of partners. Historically, Playing to the strengths of the company powerful distributors like Procter & Gamble and Unilever have managed to build strong bargaining positions and extract a Capitalizing on inherent strengths is essential for companies substantial share of the value created by the consumer goods to optimize operations and to develop a case for potential industry. We believe that a similar position of strength will partnering. We have seen how smaller companies, especially accrue to those who win the distribution race in modern energy those that are locally run, have several advantages; they are devices for the poor. often nimble and have lower costs, good local knowledge, a deep understanding of the consumer, and reach through innovative Companies can strengthen distribution by partnering networks. Larger firms have deep pockets, management strategically with businesses that have already established expertise, some value chain advantages, convening power, and strong channels. In this report, we have discussed companies the ability to scale across geographies. In some cases, astute distributing through microfinance institutions, government partnerships can tap the respective advantages of different institutions, and international development agencies. We have players. Some companies are already doing this by developing, also seen examples of and distribution through large local marketing, and cross-selling devices. conglomerates or multinationals. It is also important that energy access firms focus on Successful companies, once they have built effective distribution making the business case clear and on building professional networks, expand their product portfolios to include other management teams. Given that many start-ups begin life devices, and also bundle these products with a financing as social enterprises, the social benefits of their endeavors package. Another emerging approach with significant potential are usually well communicated. But potential investors are could be to piggyback on broader country and potentially even looking for both a strong business case and perhaps also a great 121 CHAPTER 4 international distribution networks offered by, for example, operators as anchor clients. As mentioned in the preceding mobile phone network operators. This approach could be section, mobile telephony is a sector that successfully managed used to solve several critical issues faced by many small device the last-mile distribution challenge to remote off-grid areas. innovators, notably: strong brand recognition in rural areas, There are over half a billion off-grid subscribers today, and an scaling product delivery logistics, securing working capital estimated 639,000 off-grid base stations are expected to be in finance for retailers, and providing comprehensive after-sales service by 2012, predominantly in the developing world. This service in remote communities. could present an interesting opportunity for mini-utilities to tap the anchor load potential created by base stations. Once companies have built effective distribution networks, they should consider expanding product portfolios to include Off-grid base stations are often located in remote, yet other devices, and possibly to bundle these products with a sufficiently densely populated areas to justify the capital financing package. Equally, if an energy access company has expenditure (excepting where required by regulation) and been able to develop strong networks of its own, it can leverage are normally powered by diesel generators with an average this asset to cross-sell other products, be they complementary excess capacity of 5 kW. GSMA, in collaboration with IFC, energy access devices (such as cookstove manufacturers also is currently piloting models to leverage this infrastructure for selling PV lanterns) or other products that would be desirable the extension of electricity to unserved rural communities.74 A in their target markets (for example, cell phones, radios, battery-charging service is being tested in Africa through the irrigation pumps, water purifiers). This has been demonstrated Lighting Africa program, which is exploring the commercial by a number of local cookstove players, which are now adding and operational viability of running third-party charging shops products to their portfolios and serving as distribution agents fed by the excess capacity of existing network-owned base for business partners approaching them. station generators. Here, 5 kW of excess capacity could supply around 40 households using a basic mini-grid. The concept could then be taken to the next level by using base stations as Getting the basics right: Mini-utilities must baseload clients for independent local mini-utilities. focus on developing innovative approaches to scaling up A precondition for this would be a well-functioning mini- utility that can guarantee power for the mobile tower, The first step is to secure adequate fuel or feedstock supply and however, because system “up-time” is both critical to network then secure sufficient energy demand. These may seem obvious, profitability and often a regulatory requirement. Outsourcing but both of these are described in our examples as serious base station power to mini-utilities would allow mobile challenges, alongside the strategies that successful mini-utilities operators to concentrate on the operation of the base stations, are using to overcome them. They deserve proper consideration freeing them from the noncore tasks of securing continuous at the planning stages. A number of interesting options exist power generation and protecting the equipment against theft. to build baseload. One centers around an “anchor client” in Also, a local independent operator could help mitigate the industries in or near communities needing power. Companies increasingly common community expectation that excess in remote areas could develop service agreements with larger power from mobile towers should be available at all times and government institutions. These might include agricultural without cost. If designed properly, there is potential for local training or extension facilities, clinics, and schools. They energy services companies and the mobile phone industry to could also be remote power systems operated by the incumbent partner and meet both base station power and local community utility, as Andoya has done. needs commercially. Of course, effectively capturing this latent There is clearly no silver bullet when it comes to successfully potential would require innovative business models, but also scaling up a business model, and companies need to develop training of operators, and the extension of financing options. tailored, innovative solutions, which might include serving (Figure 4.3 shows the growth of base stations in developing multiple anchor clients that are themselves owned or operated regions.) by a single company. As with devices, it is important for mini- An “umbrella company” franchise model could possibly deliver grid businesses to find ways to grow—both in order to attract the required management expertise, economies of scale, and capital and, importantly, talent, but also to capture operating capital to develop “multiple site” mini-utilities. What would it and cost efficiencies that come with scale. take for mini-utilities to replicate in the tens or hundreds of There could be significant potential for mini-utilities to engage systems across a country or region? Local entrepreneurs bring mobile base stations owned by one or multiple mobile network critical community knowledge and perhaps low overheads to WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 122 East Asia 2012 & Pacific 2007 South 2012 Asia 2007 Eastern Europe 2012 & Central Asia 2007 Sub-Saharan 2012 Africa 2007 Latin America 2012 & Caribbean 2007 Middle East 2012 & North Africa 2007 Total 2012 2007 500 1,000 1,500 2,000 2,500 Number of base stations (in ‘000) On-grid base stations Off-grid base stations FIGURE 4.3: Growth in base stations in developing regions (2007–12) Source: GSMA 2010a. mini-utility start-ups. But often the management-specific business expertise, the economies of scale to develop management systems, technology and procurement, and the finance needed to scale are harder to find. Companies struggle to develop the right span of control over dispersed systems and to manage the overheads that come with running several mini-utilities, especially those based on renewable resources with generally higher capital costs or inconsistent resource availability. Cracking the “multiple-site” business model will be critical to scale-up. Based on the commercial franchise model, an “umbrella company” might be able to bring capital, knowledge, and economies of scale in areas such as procurement to local entrepreneurs. Like a venture capital or private equity fund, it would help to identify high-potential mini-utility sites and undertake resource assessments, assist in raising debt and equity, and provide this financing to local operators, play a governance role, provide strategic advice to management, and train investees. It would also offer a standard “local electricity company operating system,” in the same way that a franchisor offers its franchisees a standard set of operating procedures. By dealing with multiple small utilities in the same region, this “operating platform” could create buying power in negotiations with suppliers, and could lobby on policy and similar issues. Several mini-utility companies are working on developing umbrella or franchise models, but more work is needed and donors can play a role in helping them innovate. Husk Power Systems comes close to this model. For now, all systems are wholly owned by HPS, but the company is exploring ways to allow more extensive and rapid growth across markets using franchises that are serviced by a central procurement and financing function. Power Source is working to develop a similar model. The approach is not new. The Commonwealth Development Corporation example, presented in box 4.1, demonstrates the success such a model can bring. But more work is needed to develop a structure that allows these businesses to successfully multiply. Here, there is a role for donors (see Recommendations for Investors #2) to support innovation on business models that help companies, particularly mini-utilities, achieve critical mass. 123 CHAPTER 4 Box 4.1: Commonwealth Development Corporation as a mini-utility developer and platform company Historically, the British Commonwealth Development Corporation (CDC) was a successful practitioner of the umbrella company concept in the Eastern Caribbean. In the early 1960s, CDC acted as a developer and equity provider for what were effectively mini-utilities in the small territories of the Eastern Caribbean region, and played a vital role in the electrification of several islands. CDC was the strategic founding shareholder in Dominica Electricity Services Limited (DOMLEC), St. Lucia Electricity Services (LUCELEC), Grenada Electricity Services (GRENLEC), St. Vincent Electricity Services Limited (VINLEC), and Montserrat Electricity Services (MONLEC), where it owned the majority of shares, generally in partnership with each island government. In each case, electrification was at very low levels when the utilities were created. Over the years, the electrification of each island has steadily increased. In Grenada following incorporation of GRENLEC in 1960, installed generating capacity has increased steadily over the years from 1.85 MW in 1960 to 40 MW in 2003 to about 49 MW in 2012. During the same period, the number of consumers increased from 550 to about 40,000 in 2003 to about 41,300 in 2012. Almost the entire country (99.5 percent) is now electrified. In St. Lucia, LUCELEC was incorporated as a private limited liability company in 1964. The company, led by CDC, acquired the electricity business and assets of the Castries Town Council and the Government of St. Lucia, and LUCELEC’s license became effective in 1965. The number of consumers has increased from about 4,000 in 1965 to 18,000 in 1985 to about 59,600 in 2012. The other three utilities have shown similar growth patterns and have achieved universal electrification. The five utilities were established on strictly commercial lines, with guaranteed rates of return. CDC ran each utility as a separate business, but kept a full-time Regional Engineering Advisor stationed in nearby Barbados. He was assisted by an electrical engineer stationed in St. Lucia who, among other things, conducted annual technical audits in each of the utilities but would also travel to each company to ensure compliance with established operating procedures and provide advice on problems as they arose. CDC also provided a central purchasing, accounting support, and financial management facility. DOMLEC, GRENLEC, and LUCELEC are all now profitable, privately owned companies. All have a mix of international strategic shareholders and local ownership, and all are listed on the local stock exchange. In contrast, VINLEC and the utility in Montserrat are now government owned, since CDC sold its shares. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? ABOVE: A LOCAL SHOPKEEPER IS ABLE TO EXTEND HIS HOURS OF OPERATION THROUGH IMPROVED ENERGY ACCESS (CREDIT: IFC) 125 CHAPTER 4 Getting the Basics Right: Grid-based Utilities Fundamentally should Focus on Becoming Fit for Purpose It is critical that grid utilities operate efficiently, which begins with reducing theft and improving payment management. For grid extension, public-private partnerships such as concessions hold promise to extend reach when they are carefully structured with incentives to connect end users. Here, it is important to prioritize delivery areas, structure subsidies to cover viability gaps (through, for example, negative concessions), and put mechanisms in place to ensure that regulatory counterparts and concessionaires are both delivering on their respective parts of the agreement. But, fundamentally, making utilities fit for purpose—that is, ensuring that they are operating efficiently—is the key point. This begins with investing in reducing both technical and nontechnical losses. While the skills and access to capital that led South Africa and Vietnam, for example, to achieve large-scale grid extension will take time to replicate in less industrialized nations, more straightforward tactics can be employed in the short term. These tactics center on preventing theft, managing payment risk, and introducing flexible payment for customers. Utilities in Brazil, Colombia, India, and Uganda provide evidence that such measures, coupled with subsidies, can lead to increased connections for the poor, and can be replicated in many other locations. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 126 Rethinking Policy: Roles for Governments and their Development Partners The private sector represents a very good potential partner for closing the access gap, but it needs to be supported by an appropriate policy, legal, and regulatory environment. Despite the best of intentions, not enough progress has been made toward achieving universal access to modern energy by 2030. Indeed, the International Energy Agency estimates that, if the current trajectory is followed, 1.2 billion people will still lack access to clean fuels and electricity two decades hence. One fundamental reason is that policy thinking has been dominated by a public sector delivery model. It should be recognized that the private sector has the best chance of contributing to closing the access gap in specific markets, and that to do so it needs to be supported by an appropriate enabling environment. Other sectors, such as financial services, telecommunications, and health care, have pioneered new and innovative ways to extend access through private enterprise, with impressive results. It is time the energy sector did the same. A first step for policymakers—governments and their development partners—is to develop an energy access strategy. Ideally this would not be done in isolation but, rather, within the context of a longer-term economic development framework. If universal energy access is to be achieved, policymakers need a plan to get there. Country-level plans should reflect the demand side (long- term growth aspirations, short-term goals), and of course the supply side (what resources exist within the local context). Within that strategy, policymakers can then define the portions of the local market that can realistically be served through private enterprise, versus those that require some public support to overcome a commercial viability gap, and a third category that cannot be served commercially. For the market segment that is commercially viable, policymakers could outline an “investment prospectus” and a clear set of rules and regulations designed to attract investors, as well as other ecosystem conditions that are needed for overall market development. These regulations may vary from country to country and, of course, by subsegment—perhaps focusing more on standards and awareness raising for devices (discussed in Recommendations for Investors #3, below), streamlined or light-handed regulation for mini-utilities (Recommendations for Investors #3, below), or smart subsidies for grid-based electrification (Recommendations for Investors #4, below). An independent “delivery” entity could help advance achievement of the energy access objectives outlined by the government. The delivery entity could play a vital role in developing data on resources and on the market, and potentially in introducing specific incentives to kick-start action or encourage first movers based on best practice (discussed in Recommendations for Investors # 3). 127 CHAPTER 4 Drawing from the analysis of our three categories of energy While this clearly benefits those receiving the products, they access solutions, the recommendations to policymakers are to: work against sustainably provided energy access in the longer 1. Resist giveaway programs and unrealistic promises term by spoiling the potentially much larger commercial opportunity for businesses to develop and sell goods that 2. Remove discriminatory taxes and duties across energy customers want, are willing to pay for and, thus, value. This is access products because customers who are willing and able to pay the full price 3. Develop specific policies to encourage mini-utilities hesitate to do so if they know that others received a giveaway. If 4. Leverage public-private partnerships and smart subsidies customers favor certain types of products, giveaway programs for grid extension also risk stunting innovation and encouraging companies to 5. Establish delivery units and build institutions to drive manufacture according to specifications that are not always quality standards, provide information on products, and optimal for the market. Free products also deter businesses increase consumer awareness of new device technologies from investing by creating risk that they will have to compete (see Recommendations for Investors #3, below). with giveaways. Promises of giveaways that never materialize may be even Resist giveaway programs and unrealistic promises worse than actual giveaway programs. The promise will stop customers from paying a commercial price, and businesses from While smart subsidies can sometimes be helpful, governments trying to serve them, blocking the commercial route to energy and development partners should avoid distorting the market access. If there is no subsidized or free product forthcoming or through well-intentioned but unrealistic promises and if the subsidy stops halfway through the program, the results damaging “giveaway” programs. Policymakers can certainly can be perverse. For example, in El Salvador, Ghana, and support and encourage private sector efforts to extend energy Nepal, donor subsidies in support of private-sector-led solar access through smart subsidies and broad sector strategies— home system plans have been unpredictable, often stopping for as long as these are limited cases with sound subsidy targeting months before starting again. The result was that companies and design that show clearly that their benefits outweigh that had viewed households as their primary target market their harm. It is also true that there could be a role for public- and that had begun to serve them profitably, subsequently sector-sponsored bulk procurement in helping to grow the prioritized institutional clients, because grant support to help market for innovative products where practical; for instance, households cover part of the systems costs was inconsistent. public institutions can help test, build confidence in, market, Following the suspension of subsidies for many months, Accra- and drive down costs through increased volumes of improved based Wilkin Solar, for example, moved away from selling solar cookstoves and solar lanterns in specific markets. Subsidies can home systems and solar-powered lanterns to urban and rural also be well designed to help those who cannot afford to pay Ghanaian households in favor of larger institutional contracts the full price of a product to buy it from a commercial provider. to service schools and clinics. But policymakers (and donors or philanthropists) should avoid distorting the market through well-intentioned but unrealistic Remove discriminatory taxes and duties promises and damaging “giveaway” programs where they may not be needed, including massively subsidizing and distributing across energy access products energy access products or initiating poorly planned or funded Policymakers can help level the playing field for energy (and thus unsustainable) subsidies in areas where they may not providers by removing taxes and duties that discriminate be needed. Some development organizations have promoted against new solutions in favor of conventional grid supply. This energy access with programs that give away or very heavily report illustrates the ways in which many governments impose subsidize particular energy access products such as cookstoves penalties on modern energy access products that are higher or solar home systems—even though these could largely be than the duties and taxes on conventional energy products. provided on a commercial basis in their target markets. Often the effects are discriminatory and perverse, creating WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 128 a bias in energy provision toward better-off grid-connected where the central grid would be extended was unclear or kept people away from poorer households, and toward conventional changing. rather than renewable generation sources. This need not be Governments should also ensure that the size and terms of the case. Barbados has one of the world’s most successful solar service area concessions are appropriate to local conditions, and water heater programs, and an essential factor in its success was should avoid granting indefinite exclusive rights. It is important the removal of all tariffs and duties on solar water heaters and to revisit the manner in which a service area is defined, both their components. This allowed the development of a local solar for a central grid-based company and for any mini-utility that water heating manufacturing industry, which is now starting may be providing power to a region. For instance, the size of to export to the rest of the region. In a number of African a concession, and terms under which a service area is granted countries, including Ethiopia and Kenya, a reduction in import and monitored, should be appropriate to the local conditions. penalties has been an important factor in increasing sales of Prior to 2000, all mini-utilities above 300 kW in Bolivia solar lanterns over the past two years. were required to acquire a concession, but the rule was not systematically enforced. This meant that some companies were subject to onerous reporting requirements, but others were not. Develop specific policies to encourage mini- The playing field was not level, nor were the returns. utilities In addition, policymakers should not award indefinite Governments and development partners can use specific policy exclusivity in a concession, because this can reduce access by to encourage mini-utilities, including service area definition, allowing underperforming mini-utilities to retain control of a regulation, and the creation of a solid revenue framework. service area. Instead, if and when concessions are allocated, the First, what a potential service area is and where it should be length of the term should be clear, and rights should be clearly must be defined. Here, it is important for policymakers to be linked to corresponding obligations within a specified time clear on where grid extension projects are likely to head, and frame. This would compel service providers to deliver on their to relax exclusivity on who can operate in other areas. Second, commitments. If agreed targets are not met, the regulator could policymakers should create appropriate regulation for mini- reopen the market to other players. utilities, rather than applying rules originally designed for large B) Institute Light-handed Regulation of Mini-utilities players. Third, a solid revenue framework for companies is critical. This involves enacting market-based pricing for tariffs; Mini-utilities do not require the same level of regulation as large facilitating service agreements with large offtakers or anchor incumbent utilities, and would benefit from reduced red tape. clients, including the incumbent utility that may be operating The purpose of regulation is to ensure that products or services remote systems; and subsidizing connection costs where supplied to the public are not hazardous. But overregulation needed. Each is detailed in the sections that follow. can be a significant issue for often modest-sized businesses such as mini-utilities, which can typically operate efficiently A) Rethink How Service Areas are Defined and safely with fewer rules and less onerous paperwork.75 In Policymakers first need to provide mini-utilities with clarity on many countries it is illegal to supply power without a license its grid extension plans; in this regard, regulation is required or permit. Yet the processes required to get a license can be to protect investors. In order for a mini-utility to take a an insurmountable barrier to small businesses seeking to decision on whether or not to invest in a given area, it needs to supply power in rural areas. As a result, these ventures are, at understand both the likelihood that it will make an acceptable least technically, criminal enterprises, preventing them from return on investment, and its rights and obligations after the growing, formalizing their business, raising finance, or selling investment is made. A major barrier to mini-utility developers out to a larger operator. coming into a given area is uncertainty about how long it will Policymakers can reduce red tape by simply relaxing licensing take before the main grid is extended to that same location. requirements, and instead requiring companies to register with Hence, perhaps the first step for energy planners and other a regulator or other government authority. The number of policymakers is to be clear on where grid extension projects regulatory requirements or decisions, the number of government are likely to head. In India, for example, there are a number entities making separate decisions, and the amount of information of cases of mini-grid developers being hesitant to set up plants required for the entities performing electrification should be in certain communities because the government’s policy on 129 CHAPTER 4 adjusted to attract and not stifle mini-utilities.76 There are several ways of easing the burden on mini-utilities while, in general, improving efficiency. For example, rural electrification agencies can be delegated to decide on tariff and concession terms, with no further formal review required by the electricity regulator. Alternatively, a national or provincial regulator can designate the rural electrification agency as its agent, with decisions taken on a no-objection basis. In Nicaragua, mini-grids are regulated by contract and law, with streamlined reporting rules and formal steps. Safety concerns can be addressed by enforcing clear laws on safety and consumer protection, with regular inspections. Offenders should be shut down, similar to the way in which health and safety concerns are addressed in the hospitality industry. Where mini-utilities operate illegally because of difficulties in getting a license, they are not subject to any kind of effective safety regulation at all, whereas our suggested approach would bring all electricity providers under enforceable registration and safety obligations, without imposing other unnecessary burdens. This approach has worked well in India, where the 2003 Electricity Act requires only that power providers in rural areas comply with safety rules. In Sri Lanka, the government sets technical specifications and safety standards and allows companies to “self-regulate.” Policymakers also have an opportunity to extend energy access by removing rules that make it illegal to serve people who do not have formal title to their land—as Jamaica and the government in Delhi did. Going further, governments should consider removing rules that make it illegal to supply households that lack properly certified wiring, or providing support to such households to install such wiring. C) Create a Solid Revenue Framework for Mini-utilities Governments can help develop a solid revenue framework for mini-utilities through a combination of appropriate tariff regimes, connection subsidies, and support for handling nonpayment. For mini-utilities to thrive, they should be allowed to make a return on investment. This requires that revenues be of a level appropriate to the nature of their business, and that supportive structures be put in place to help them manage excessive risks or income deficits. A solid revenue framework for this subsector would have three components: an appropriate tariff regime, connection subsidies where there is a viability gap, and a facility to handle nonpayment by large clients where relevant. Ideally, mini-utilities should be allowed to charge market prices—rather than be subject to tariff regimes designed for centralized plants—at least until they are established and can exploit economies of scale. Some countries have capped mini-utilities tariffs at the same level as grid utilities, which are often loss making and subsidized by the government, while others have set tariffs for mini-utilities separately, but still below the level needed to earn a commercial return on investment. Tariff caps are intended to counter the natural monopoly of typical grid utilities, and to make electricity affordable for the poor. But often they have the opposite effect by making it unviable for mini-utilities to enter the market. Mini-utilities typically have a higher cost of service than large integrated grids, but where they are used solely for lighting purposes they compete with solar home systems and lanterns. For example, in Cambodia, mini-utilities began and flourished with no tariff regulation. In Mali, the rural electrification agency differentiates tariffs by the type of supplier, reflecting their different cost structures. Subsidies can help where significant capital expenditure is needed to connect a consumer to an energy service, but cannot realistically be paid by the user. Grants (ideally administered based on outputs) would be a good way to cover connection costs where needed, helping to close the viability gap between realistic and commercial returns. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? ABOVE: A VEGETABLE SELLER LIGHTING HIS STORE WITH A SOLAR LANTERN (CREDIT: IFC) 131 CHAPTER 4 If tariffs, connection subsidies, and revenue frameworks are attractive, there is a high likelihood that developers will enter the market. Andoya Hydroelectric Power Company in Tanzania is an example. First, Andoya benefits from a comprehensive revenue framework comprising three elements: attractive tariffs, a long-term debt facility, and a connection subsidy. Based on current regulations, tariffs are set at about $0.23/kWh (385 Tanzanian shillings), which is significant for this hydropower-based mini-utility, given low operating (and no fuel) costs. Second, with the help of a long-term credit refinancing facility from the World Bank, it can get long-term local loans from banks for 70 percent of project costs. Third, a World Bank and Government of Tanzania facility provides Andoya with a $500-per-connection grant—which counts as owner’s equity—to connect household customers, thus providing substantive capital up front without which this project would not be possible. As an added bonus, the project is expecting to secure carbon revenue advances, given that it will offset diesel-based generation by Tanesco. A World Bank and local Rural Energy Facility guarantees market-based carbon income until 2020, much beyond the existing Kyoto regime, and provides a three-to-four-year equity advance based on future carbon revenues. This substantive, interlinked set of incentives and support structure makes possible a project that benefits the local community, entrepreneurs, the utility, and small businesses. Other forms of revenue guarantee could also be used to facilitate mini-utility development. Under the Tanzanian standardized power purchase agreement, Tanesco is legally obliged to pay for the power supplied by small producers. There is no guarantee, however, on the utility’s payment, so if Tanesco’s financial situation were to worsen and it could no longer honor its obligations, the mini-utilities would take the hit. Policymakers and the donors that support them should consider payment guarantee plans for offtake from public sector anchor clients. Leverage public-private partnerships and smart subsidies for grid extension Where the cost of service delivery is prohibitively high and public finance is scarce, governments can leverage public-private partnerships to extend access. In the case of grid extension, public utilities should serve public purposes including extending access to electricity. But in many countries, a lack of finance or other problems prevent this even in areas that could be cost- effectively served by grids. Rwanda, for example, has one of the lowest electrification rates in the world—just 10 percent of the total population has access to electricity. In other words, only about 110,000 households are connected. Yet more than half the population of Rwanda lives within 5 kilometers of the existing (state-owned) transmission and distribution grid. Recent in-depth studies77 showed that despite low income levels, more than 370,000 households would be willing and able to pay the full commercial cost of grid extension, thus quadrupling the number of people connected to the grid without any significant public sector financing. One way to potentially improve the efficiency of grid-based electricity access is to privatize distribution systems. Another is for governments to award concession contracts for new or privately owned distribution companies to serve currently unserved areas. This can also be combined with smart subsidies to extend access even further than would be viable on a purely commercial basis. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 132 Private companies often bring access to capital and new management approaches that allow them to increase connections more quickly than public utilities, while improving the bottom line. The most comprehensive and meticulous analysis to date of the performance of privatized utilities compared to public utilities78 finds that the increase in the number of connections for utilities privatized as concessions is 21 percent higher than the increase in connections for utilities remaining in public hands. Private companies are often able to access capital to expand the network, something that many publicly owned utilities may struggle with. Moreover, private companies often bring new management approaches that allow the costs to be reduced and revenues increased, thus providing a return on the investment. Access can be further extended through smart, technology-neutral subsidies and targeted concessional finance, although support should focus on impact and avoid unintended market distortions. For instance, to build the market in Bangladesh, IDCOL (Infrastructure Development Company Limited) has been giving a declining subsidy on solar home systems sold in Bangladesh, starting from $90 for the first 20,000 units, and falling to $25 currently. This has helped a range of commercial market providers to enter the market with solar home systems that meet specified standards adjusted over time, collectively installing about 1 million units as of June 2011. While this declining payment is the ideal way to structure public funding interventions, one downside of this particular program has been a focus on specifications for modular home systems. As a result, firms offering solar lanterns and solar kits, which cost perhaps one-third of a traditional solar home system, have a hard time entering the market. Similarly, there should be a mechanism to ensure that projects deliver promised connections and do so in a reasonable period of time. The Comasel concession in Senegal, for example, meets all necessary requirements in terms of filling the viability gap with Output-Based Aid, but has yet to deliver a single connection several years after being signed. A number of issues are at play on the part of both the operator and the regulator, but an important shortcoming has been the inability to renegotiate contracts because delivery timelines have not been honored. 133 CHAPTER 4 Refocusing Financing: Opportunities for Impact and Commercial Investors Both impact and commercial investors can play a critical role in scaling up energy access success stories. Impact investors are financiers seeking either a social return or a combination of social and financial returns (such as social venture capitalists, local development banks, philanthropists, and international development agencies). Commercial investors seek largely or purely financial returns. There is scope for commercial investors to make good returns by serving the energy poor, but the sector may be more suited to impact investors seeking both social and financial returns. Despite the promise of the energy access market, this is still an early-stage opportunity for capital seeking only high financial returns. Most investment capital to date has come from impact investment funds, which have been a good match for the sector: they are patient, have appropriate risk/ return profiles, and are also more willing to sit down and listen to the story of smaller companies. Some commercial funds have supported larger grid extension projects with attractive revenue streams but, generally, this sector is ideal for impact investing because it involves the attractive combination of renewable energy, social benefits, and the base-of-the-pyramid market. New venture funds have recently emerged, however, targeting proven energy access companies, raising the risk that a relatively large pool of finance may soon be chasing a handful of high-profile enterprises. In just the last two years, a number of new venture funds have emerged, generally seeking energy access investments with a proven business model, two to three years of financial statements, highly experienced management teams, and the ability to absorb $500,000 to $5 million. While interest in the sector and the emergence of investable companies are good things, the reality is that few companies matching this profile exist. And when they do, they tend to be piled on by investors, often causing much distraction to management’s ability to focus on operations. As a result, hundreds of millions of dollars in financing may soon be crowding a limited number of high-profile investment-ready enterprises. To better support the market and meet their own return expectations, all investors would benefit from keeping investment mandates broad and beyond a single technology (for example, avoid solar-only or cookstove-only funds), and include firms offering other products in low-income markets in their portfolios. Rather than technology, one might look for critical success factors relevant to the subsector—such as strong distribution channels in the devices space—as the common denominators for an investment approach. This could mean taking lighting and cooking devices, water purification systems, and cell phones as offerings with common characteristics; they have similar price points and need comparable distribution networks and financing. Investing in microfinance institutions that can also serve as energy device distributors may also make sense. To broaden the deal pipeline, investors would benefit from “deal marketplaces” and a well- developed local presence that helps surface hidden gems. Without a good infrastructure, be it in the form of cooperative agreements with local NGOs and international agencies that work with or come across energy access businesses, or by setting up a local office to stay on top of the market, it will be difficult to find lower-profile companies—many of which may be at the community level but hold potential for significant scale. Beyond this, there are three primary areas for both impact and commercial investors to act to further catalyze successful energy access businesses. They are: • Providing appropriate funding for each part of the business life cycle • Supporting enterprise development and business model refinement • Funding delivery units, and the provision of public goods: Resource mapping, market data, consumer awareness, and standards. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? ABOVE: A BOY USING A SOLAR-POWERED TORCH (CREDIT: IFC) 135 CHAPTER 4 Providing appropriate funding for each part of the business life cycle As indicated in figure 4.4, there are a number of places along the business life cycle where investors can play a role. The early part of the cycle lends itself to impact investors while, as companies mature, they are a more natural fit for commercial investors. What is key is that financing is needed throughout. The early stages of the company life cycle often require concessional finance79 to cover business model conceptualization, piloting, and other activities that get the business to proof of concept. Commercial funds Investors must address the “missing middle” funding needs of the sector between Concessional funds $50,000–$100,000 and $3–$5 million. Business Model Development Proof of Concept Maturity The provision of mezzanine Profitability financing can enable banks to lend to projects that would not get debt financing otherwise due to high risk. Break- even Technology/business model advancement Grant funding Grant funds can s "OTHCONCESSIONALAND Carbon prefinancing Working capital at can support help scale and commercial debt and equity has potential to commerical rates is start-ups and replicate promising are required to finance the generate additional required throughout build an business models, start-up and growth capital revenue for both the business cycle. investment possibly through needs of early-stage energy cookstoves and some Double bottom line and pipeline. incubators or by access businesses. mini-grids, and more commercial investors testing structured approaches could offer trade finance high-potential s $ONORSCANFUNDEXPENSIVE could help make it to groups of companies business models. R&D that shows sectorwide more accessible. in the same or related promise. energy access spaces. FIGURE 4.4: Financing is needed in three areas: To support companies in their early stages (start-up and growth capital), to support operations (working capital or trade finance), and to strengthen revenue streams Source: IFC analysis. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 136 Both debt and equity are required to finance the start-up and growth capital needs of early-stage energy access businesses. Investment funds find the sector appropriate for equity financing, due to the high-risk/high-growth nature of the companies, the need for multiple rounds of financing, and the potential for a trade sale. And, generally, for scaling up and business expansion, equity is more appropriate than debt financing. For working capital financing, including for import, inventory, and stocking, manufacturers would prefer to use debt but have faced difficulty finding it at an attractive price. Once companies are housing inventory in multiple localities, the accounts receivable gap is expensive to finance by debt capital. Where debt is required, various instruments, supported with concessional financing, can be structured to encourage reluctant financial intermediaries to provide most needed debt financing to the projects. The example of risk-sharing facilities is discussed in box 4.2. 137 CHAPTER 4 Box 4.2: Understanding financing constraints For many of the companies operating in the energy access space, capital in the form of equity and debt is critical to help finance their operations and growth. There appears to be no shortage of capital per se; rather, it is difficult for companies to access the capital that exists. As discussed in Chapter 3, venture capital is difficult for small companies to secure, particularly those operating in risky and poorly understood markets, and where exit options for investors are limited. Where venture capital is an option at all, the amount required may occupy an awkward space between large deals sought by major private equity players and local angel financing. It is now relatively easy to raise financing for, say, a $100 million investment in a power project in a developing country. Development financiers such as IFC and the Dutch development bank, FMO, will invest in projects of this size, as will a range of purely commercial investors and developers such as Actis or Macquarie— provided that the project is financially sound and backed by strong and experienced sponsors. There are also a number of socially minded investors who might provide a few tens of thousands of dollars in early-stage financing; while initially helpful, these amounts of capital usually help the management team for a couple of months, but then the fundraising starts again. Due to high transaction costs, few players are interested in making an equity investment measured in the hundreds of thousands of dollars. For bigger funds, the costs of due diligence, transaction, and monitoring become disproportionate to the small value of the investment. For smaller funds, these sums are more than they can afford in a single deal. Beyond this, there is the question of debt. As with many relatively early-stage ventures in other sectors, commercial banks are skeptical of extending debt to many high-potential mini-utilities, even those with sizable operations such as Husk Power Systems, because they have yet to demonstrate full commercial viability or because they do not have the generally accepted two to three years’ worth of financial statements. In that case, HPS managed to secure a $750,000 loan from the U.S.-based Overseas Private Investment Corporation (OPIC), but this is an amount that many small firms cannot absorb. In general, however, banks are commercial entities and their actions are driven primarily by factors such as transaction costs, the risk/return profile of loans, and the availability/cost of funding. The result is a negative bias against companies requiring small-scale finance and with a short operational track record. Small-scale project finance is an oxymoron: Project finance in its pure form is the provision of tailor- made financing for a new investment based exclusively on the cash flow and assets of the financed new investment. Nearly all larger energy investments are financed with project finance. The key benefit is that it can provide financing that is designed to fit the risks and cash flows of a specific project. While nearly every bank offers project finance, lenders are also conscious of the high transaction costs associated with this option. Therefore, project finance is offered essentially only where transactions exceed a certain minimum investment amount. Smaller projects, in both developing and developed markets, are typically financed with corporate loans. However, in most developed markets, the differences between larger SME loans and smaller project finance loans are less dramatic than in developing markets. In developing markets, a project that is financed by corporate loans instead of project finance loans typically has to deal with: • Significantly higher equity requirements • Onerous requirements to provide collateral in addition to the project assets • Higher interest rates • Shorter terms • Unavailability of postcompletion refinancing. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 138 The combination of these constraints results in many sponsors abandoning smaller projects because they lack the equity required by the banks. If the sponsors can afford the required high equity, the risks often result in returns that are too low. What makes a project bankable, or not? In many market situations, the viability of projects or companies is decided primarily by financing conditions. In particular, capital-intensive renewable energy technologies like PV, wind, or small hydro are only feasible if the financing conditions are acceptable. To illustrate this constraint, let us look at the following hypothetical small hydro example: • Investment cost: $10,000,000 • Projected annual revenue: $1,200,000 • With a loan tenor of 10 years and an interest rate of 9 percent per year, the project can comfortably be financed with 30 percent project equity. However, if the available financing tenor is only five years, the project promoter would have to finance 54 percent of the project with equity to be able to make the project viable, which is typically a prohibitively high equity requirement. Lack of track record: In most markets, providing access to energy is still, from a commercial point of view, a risky and untested enterprise. This is typically compounded by the fact that the entrepreneurs have only a limited track record. For banks, these are indications that such companies are particularly risky and should therefore be avoided as loan clients. For example, a common complaint of small- scale operators in India is that, while funds are available through the Ministry for New and Renewable Energy (IREDA), they still face issues in raising financing because the scale of their plants often falls below the minimum level set by that facility. Moreover, where IREDA does provide financing, the entrepreneur still has to raise additional loan guarantees from banks, and these institutions are not willing to lend without any personal guarantees. As a result, bank financing is available only if the firm shows three years of profitability. Even where local banks are willing to lend, they typically offer short- term financing at a high interest rate. The provision of mezzanine financing80 can enable banks to lend to projects that would not otherwise get debt financing due to the high risk aversion of banks. With the support of concessional financing, IFC is piloting such a mezzanine facility to support individual transactions in the following way: • The bank identifies a transaction that complies with agreed eligibility criteria—in this case that it provides energy access. • While the bank is not comfortable with the risk of the identified transaction, the project complies with simple agreed financial criteria. • An independent party selected by IFC confirms the technical viability of the proposed project. • IFC would then assume a subordinated position in the financing of this project.81 For the bank, IFC’s subordinated participation would indirectly increase the project equity and therefore greatly enhance its creditworthiness. For the project developer, the loan would simply be slightly more expensive debt that helps to overcome the main hurdle, that is, obtaining financing. 139 CHAPTER 4 Box 4.3: Risk-sharing facilities can encourage the provision of debt Risk-sharing facilities (RSFs) are sometimes used to encourage funding of early-stage companies where banks are hesitant to lend to a new sector. RSFs are in essence a loss-sharing agreement between an originator of financial assets (a bank or other lending institution) and a commercial guarantor—such as IFC or Kf W—or a donor (see figure B4.3, and box 4.4). The guarantor, or donor in cases where a commercial guarantor cannot assume the first loss, reimburses the originator for a portion of the losses it incurs on loans in a sector or line of credit that is of interest to them. RSFs are typically provided as guarantees, but they could also be implemented as funded transactions. RSFs are portfolio mechanisms and they typically have an impact when: • A bank faces an industry exposure constraint; this typically does not apply to energy access, however, since there are currently almost no loans to such players. • A bank considers the loan sizes of certain projects too large but is in principle comfortable with the credit risk; given the small transaction sizes to be supported, this is not a constraint for energy access. • A bank wants to enter a certain market segment but is wary of the risk of these borrowers and an RSF would reduce this risk somewhat; this case could apply for the energy access markets. RSFs are not always appropriate for energy access markets, but could potentially benefit mini- utilities in countries experiencing growth in that sector. RSFs, however, do not change the economics of individual transactions. If a bank is uncomfortable with an individual transaction, which is typically illustrated by requiring more equity/collateral, a traditional RSF will not improve the situation. RSFs require deal flowa to create a sufficiently large loan portfolio, and hence could be hard to establish where there are insufficient capital needs or a critical mass of companies on a national or subregional level, for example, where only a handful of device companies in a given region have appropriate financing needs. The mini-utility sector could potentially greatly benefit from a risk-sharing facility in countries such as Cambodia and India, where many of these companies are starting up and are in need of growth or expansion capital. Risk-Sharing Facility Financier/Donor Originator Shared loss Originator 1st tranche loss Financier/ Donor Risk Originator Risk Risk-Sharing Facility Interest Risk Portfolio of Loans Loans FIGURE B4.3: Structure of a risk-sharing facility Source: IFC analysis. Note: a. Deal flow refers to the number of potential investments or transactions that an investor sees and is able to evaluate for possible. Having a large and viable pipeline is a key success factor for most investors. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 140 Box 4.4: Examples of risk-sharing facilities RSFs have been set up around the world for a wide variety of loans. This includes mortgage loans; consumer, student, school, and energy efficiency loans; and SME loans. Examples include: Student Loans in Indonesia: IFC helped overcome the low enrolment in tertiary education caused by financial difficulties of poor students in a risk-sharing agreement with a private educational foundation and a private sector bank. The RSF was set up to leverage the foundation’s contribution by reducing its risk and, thus, offering more attractive interest rates to students. IFC provided a guarantee for 50 percent of the losses incurred beyond the first loss threshold. China’s Utility-based Energy Efficiency Finance (CHUEE) Program: In 2006, IFC launched the CHUEE Program to support energy-efficiency-related lending to increase energy savings and reduce carbon dioxide emissions in China. IFC has provided RSFs to three banks—the Industrial Bank, Bank of Beijing, and Shanghai Pudong Development Bank—for a maximum total portfolio size of $497 million. Concessional funds from the Global Environment Facility have been used to provide first-loss coverage. As of December 2010, a $402 million portfolio of 163 loans was covered by the RSFs. Projects included industrial boiler retrofitting, wasted heat recovery, power savings, and optimization of energy use. The partner banks and other market players have also received advisory support. Kenya’s School Risk-Sharing Facility: IFC helped bridge the gap of supply and demand in the education sector in Kenya by extending the tenor of the available financing for investors in private schools. To do so, IFC engaged in a risk-sharing facility with K-Rep—a bank with a local currency portfolio of loans to private schools—to finance construction, purchase of educational materials, and other capital expenditures. IFC agreed to cover 63 percent of all losses beyond a 5 percent first-loss threshold. This risk reduction allowed K-Rep to increase the tenor of the loans it offers. The demonstrative effects of this endeavor are expected to lead other banks to target the education sector. Double bottom line and commercial investors could offer trade finance to groups of companies in the energy access sector. Investors can usefully offer trade finance to individual companies, but it might be more efficient to establish facilities for larger groups of companies. A sizable facility open to local and international fi rms making devices, solar home systems, or components for mini-grid systems, would help unlock supply chains and facilitate market penetration. The recently established and EU-backed Solar for All initiative, whose Solar Fund targets investments of around €3 million in the PV sector, will leverage a range of instruments designed to work along the supply chain, including providing working capital to companies. As the fund progresses, it may do well to consider widening its focus beyond PV alone. Across the investment capital and trade finance spaces, it is important to address the “missing middle” funding needs of the sector. There currently appears to be a mismatch between the type of funds that energy access businesses need and what is available from a range of financiers. A better fit with the needs of the sector would be local currency investments between the “too small” ($50,000 to $100,000) investments typically available from philanthropists, on the one hand, and the “too big” ($3 million to $5 million) investments offered by larger institutions, 141 CHAPTER 4 including many development finance institutions, on the other. This is not a hard-and-fast rule, but it is worth considering. For example, table 4.1 outlines typical financing means for off- grid lighting manufacturers. The table illustrates how emerging players with growing but still relatively low sales and a limited track record could fall into the “missing middle,” struggling to raise investments of $0.5 million to $5 million. Type of Stage Typical Financing Means Manufacturer Emerging off-grid No revenues Founders, angels, and foundations provide equity and short-term lighting No track record debt to finance the start-up of the company. manufacturers <$0.5 million sales Founders typically leverage initial equity investment by raising 0–3-year track record some additional debt. Established off-grid $0.5 million–$5 million Challenging phase to raise capital as manufacturers grow beyond lighting sales the capacity of angels but find it difficult to raise money from manufacturers Limited track record investment funds; this is the “missing middle.” >$5 million in sales Manufacturers are turning primarily to equity from investment Longer track record funds, because it is cheaper than debt to finance expansion. However, as they approach the $7.5 million mark, their willingness to take on equity typically declines and is replaced by debt financing. At that point, their business models have gained traction in the market, major risks have been mitigated, and working capital that is needed to finance growth takes center stage. Table 4.1: Where energy access companies look for financing, off-grid lighting example Source: IFC analysis. Finally, carbon prefinancing has the potential to generate additional revenue for both cookstoves and some mini-grids,82 and more structured approaches could help make it more accessible. Of course, given the constraints of the process and uncertainty about its future, business models must be viable without this revenue stream. Still, more structured approaches could help make this instrument more universally accessible than the valuable but isolated efforts of impact investors to date. Currently, a rigorous registration and monitoring process83 results in a three-to-four-year gap between registration and verification of carbon reductions before carbon money starts flowing. In addition, the transaction costs involved in setting up and monitoring make carbon finance attractive only for companies that are able to aggregate a sufficient number of sales. Current mechanisms to pay firms for carbon emissions reductions suffer from major problems. Payments under the Clean Development Mechanism are linked to the continuation of the Kyoto Protocol or a similar successor, which is in jeopardy, and to the rules of the EU Emissions Trading System (EU-ETS), whose future development is also unclear. Payments under the Voluntary Emissions Reduction approach do not have the same regulatory uncertainties as the EU-ETS, but are much lower than the price of carbon emissions reductions in the EU-ETS. Moreover, certification programs are designed to be applicable to all types of emissions reductions projects so they are more complex than strictly needed for any one type of project, such as improved cookstoves. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 142 In this context, financiers and donors have an opportunity to make it easier for firms to monetize the carbon dioxide equivalent emission reductions they provide. Financiers may purchase or lend against Certified or Voluntary Emissions reductions. Donors could also create simpler finance plans with lower certification costs. For example, a donor could set up a program that would test stoves, and then purchase the rights to the resulting emissions reductions for a fi xed price. Doing this on a programmatic basis by country or region could reduce costs compared to current approaches, increasing energy access and reducing carbon dioxide equivalent emissions. Supporting enterprise development and business model refinement Financing for energy access companies should be linked to advisory services that build management skills and help refine business models. Capital is often only half the battle. Energy access companies also need skilled entrepreneurs and new business models. It is therefore critical to link capital with advisory services that build business acumen and management skills. Additional support is also needed to refine business models more broadly. Grant funds can be used to help identify, scale, and replicate promising access ventures. Initiatives such as the Ashden Awards, the World Bank’s Development Marketplace, and the Africa Enterprise Challenge Fund have already made a real contribution to surfacing innovative companies. But additional funding channeled through new or existing incubators that source and nurture promising ventures, run regional business plan competitions, organize training for entrepreneurs, and forge links with local business and engineering schools and partnerships with financial institutions, could help accelerate the process.84 Combining investment and technical assistance funds is not new. One company based in the United States but which operated globally, took such an approach in the energy access space for well over a decade, and provided seed and growth capital to renewable energy businesses in Africa, Asia, and Latin America, investing $25,000 to $1 million. In parallel, the company provided capacity-building services designed to prepare clean energy businesses for investment, including business plan development, risk identification and mitigation, basic bookkeeping and financial modeling, organizational and ownership structuring, and legal and regulatory assistance. The World Bank Group’s infoDev is designing and launching a network of Climate Innovation Centers to help small emerging market clean tech businesses grow, access knowledge, and link to international markets.85 The recently commenced Shell Foundation Business Accelerator (box 4.5) is taking a similar approach, but specifically for access. Mumbai-based Dasra fulfilled a similar role for community organizations for 12 years until three years ago when it extended its offering to include social businesses.86 Efforts like these should be expanded across all energy access sectors. 143 CHAPTER 4 Box 4.5: The Shell Foundation is taking a venture capital approach Shell Foundation is an example of an organization that deploys grant funding to for-profit enterprises that provide energy access to the poor. It has also created two financial intermediaries to address the wider gaps that exist in the Indian market. The first is a Business Accelerator created in partnership with First Light Ventures, which will provide risk capital (up to $400,000 in convertible debt) to seed stage companies in the energy and affordable basic services sectors. The Accelerator will also provide meaningful levels of business development assistance via a dedicated team based in- country. Companies will be chosen for their projected ability to raise significant scale-up funding from next-stage investors within 18 months. This approach—where Shell Foundation’s grant is pooled with First Light Ventures equity and deployed as convertible debt by First Light Ventures— allows both organizations to leverage their capital and make a greater number of investments at larger ticket sizes than either would do individually. The second intermediary was created to help address the lack of commercial debt financing to SMEs in India. In late 2010, Shell Foundation launched a credit facility in partnership with IntelleCash, an Indian nonbanking finance company, which provides commercial debt (less than $250,000 per loan) tied to specific anticipated cash inflows. The facility specifically targets small businesses that do not have three-years-plus profitability or full collateral (that is, are not able to be served by banks), comprising the “missing middle” asset class. The Shell Foundation has plans to scale the facility in ways similar to their strategic partner GroFin, in Africa. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS STORIES? 144 If promising companies are well screened at the due diligence new energy access unit tasked with and accountable for making stage, a fairly small amount of technical assistance funding progress on this front. In either case, such a body will need can help determine whether they become bankable. For to be empowered to deliver results, and ought to be resourced instance, one company estimated that if the cost of its business appropriately. Although still early stage, such an entity could development support services were passed on to investees rather be modeled along the lines of delivery units used to implement than absorbed by donors, this would increase the cost of debt agricultural sector priorities in Ethiopia (Agricultural it provided from about 12 percent to 15 to 18 percent. At the Transformation Agency) and overall economic development early stages of a business’ life, that 3 to 5 percent “subsidy” is activities in Malaysia (Performance Management and Delivery a good investment. Unfortunately, there is currently a lack of Unit). It would begin by defining specific energy access targets funding for the kinds of blended capital business incubators by technology and over a given period of time (for instance, and accelerators described above. access to clean cooking options, decentralized electrification, or grid connections), and would then articulate a road map for One reason could be the focus of donors (philanthropists, achieving them. It would need to be resourced appropriately development execution agencies) on technical assistance, to bring best practice in regulation, business models, financing and of development finance institutions on investment. A options, and implementation capacity to bear, and to ensure second reason could be that donors sometimes shy away from active tracking of and reporting on progress. And, importantly, supporting companies that make a profit, preferring to focus on it would need to be empowered to recommend policy changes ventures with a primarily social bottom line. Meanwhile, given where needed and have a reporting line to or direct support the risk of early-stage companies, most commercial investors from key decision makers to ensure the desired impact. While do not have the luxury of reducing their returns by subsidizing the actual management of such a delivery entity would be a capacity-building activities. natural role for government, grant funds could help to kick- Grants can also meaningfully advance sector development start activities, by financing its set-up (strategy, organizational if used to support business models more broadly. Over the design, staffing) and potentially part of its operations. last decade, a number of development agencies have invested Grant funds can also be leveraged to finance the provision in selected public good areas, notably R&D on appropriate of market and resource data, and to develop standards. technology, and public awareness raising on alternative energy Companies have great difficulty financing high-cost items options.87 These efforts have often helped small firms overcome that would benefit their businesses. This includes developing significant hurdles to the introduction of new technology and market intelligence; profiling the availability of primary therefore made a valuable contribution to access. But more energy resources; and creating industry standards to guide targeted funding of business model development activities manufacturers, distributors, and service providers. In the is needed, particularly in the area of mini-utilities. One area devices market, this helps companies better understand and needing more work, for example, is on ways to scale-up mini- segment customers, develop tailored products and models grid businesses. In this space, we see limited progress, but we to serve them, and establish the necessary (hard and soft) have also only begun to scratch the surface on early ideas for infrastructure. models mentioned in this report, such as linking to an anchor- client, microfranchising, or developing umbrella companies. In the mini-grid and grid-based access markets, these enablers This can be achieved by supporting entities that focus on help companies effectively complement utilities and rural developing and testing commercial approaches to energy access energy agencies by providing valuable information on where product or service delivery. to site systems and how to size them.88 Finally, standards benefit the entire sector because they help ensure the quality of products and services and, importantly, level the playing field. Funding delivery units, and the provision Consumer awareness is another public good that is critical of public goods: Resource mapping, market to a business seeking to enter new markets, and can usefully data, consumer awareness, and standards be supported by donors. Chapter 3 illustrates how the cost of Governments and donors will need to take a coordinated building public awareness can make a difference between a approach to energy access if transformative results at the company making a profit or posting a loss, and how donor- national level are to be achieved; a “delivery” entity can help in supported funds have made this difference. This leads to greater this regard. The entity could be an existing regulatory body with sustainability for companies in the long term, transforming the additional mandates related specifically to energy access, or a market for cleaner solutions. 145 CHAPTER 4 APPENDIX Appendix A: Market-sizing Methodology This appendix explains the methodology, data used, and assumptions made in this report regarding market size, and provides additional sensitivity analyses. The “addressable market” is the number of households that could afford to pay the full commercial price of a service (based on current spending levels for traditional energy), if it was offered by an efficient company, earning a commercial return on capital but not constrained by lack of finance or excessive regulatory restrictions. The addressable market estimate.89 further assumes business, governments, financiers, and donors all play their part. It is, therefore, a theoretically addressable market since these assumptions hold to different degrees across different geographic locations. To assess how many additional households could afford modern energy services, the amount they are spending now on traditional energy is compared to the monthly cost of a range of modern energy services and products that would provide superior alternatives to traditional energies. These costs are commercial costs. They are based on actual observed costs of money-making enterprises supplying such services now. Our analysis shows that more than 90 percent of households could be commercially served with modern energy solutions, since they already spend more on traditional energy than the commercial cost of superior, modern energy solutions. Data and Assumptions for the Market-sizing Methodology Main data source for energy expenditures Data for the household expenditures on lighting and cooking are derived from estimates on household and per capita expenditures in “The Next 4 Billion: Market Size and Business Strategy at the Base of the Pyramid,” a report published by IFC and the World Resources Institute (2007). The data presented are ultimately derived from expenditure data from household consumption surveys and were standardized as part of the 2003–06 round of the International Comparison Program (ICP) at the World Bank, which aims to produce internationally comparable price levels, expenditure values, and purchasing power parity estimates (PPP). For comparison across countries, the ICP has classified products and services into 110 categories that broadly cover different household expenditures. “The Next 4 Billion” focuses on the base of the pyramid (BOP) market and presents household expenditure data for 36 countries for the population with annual per capita expenditures ranging from $500 PPP to $3,000 PPP. These 36 countries are broadly representative of all the countries in the world. Per capita expenditures are categorized into 10 broad markets, one of which is energy. Estimates for household expenditures on lighting and cooking are based on the estimates for energy expenditures from “The Next 4 Billion.” Assumptions Proportion of expenditures on lighting and cooking Household expenditures on energy include both electricity and cooking. To determine the proportion of each, we drew upon expenditures on different fuels from national-level household surveys. Data for this breakdown are not readily available for most countries, especially data with a focus on the population without energy access, so our methodology applies a global average based on indications from a number of selected countries. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS APPENDIX STORIES? 146 In general, we estimate that the share of energy expenditures is roughly equal between electricity and cooking. However, this allocation is correlated with income. Based on data from the Indian national household surveys,90 the average urban household in India spends roughly 51 percent of its energy expenditures on fuels related to lighting and electricity (mainly kerosene and electricity) and the rest on cooking. For a rural household, 35 percent of expenditures is spent for electricity and 65 percent is spent on cooking. Estimates from the Bangladesh Institute of Development Studies (BIDS) Survey of rural households in Bangladesh indicate that expenditures on lighting are higher than in India and range from 57 percent to 64 percent, depending on income levels. For Peru, estimates from the National Survey of Rural Household Energy Use show that households also spend a greater percentage of their total energy expenditures on lighting and electricity, estimated at about 65 percent. For the market-sizing methodology, the assumption for the proportion of lighting and electricity to cooking is 40 percent and 60 percent, respectively, for the poorest households, and increases to 60 percent and 40 percent for wealthier households. The impact of these assumptions on the addressable market can be drawn from the sensitivity analysis on willingness to pay, addressed below. Cash-only expenditures The size of the addressable market depends on the ability of potential customers to pay for improved energy products and, therefore, estimated expenditures for households should only reflect cash expenditures on energy. Estimates reported from household surveys will sometimes include the imputed cost of freely collected fuel as part of total expenditures. While fuel for electricity and lighting is rarely collected or home grown, collection of fuel for cooking for urban and rural households ranges between 20 and 60 percent of total consumption. As a conservative assumption, estimates of collection rates for fuel wood and charcoal from urban and rural households in India were applied to reduce the household expenditures on cooking fuels for all households. Our assumptions are that rural households purchase 40 percent of fuel wood and urban households purchase 70 percent of fuel wood. Scaling up to 2010 population estimates This report focuses on the population that currently lacks access to modern energy. For the lighting and electricity market, the target population is unelectrified households in the developing world. For cooking, the target population is households without access to modern cooking fuels or improved cookstoves. Our estimates for both populations start with 2010 population estimates from the UN Population Division of the 36 countries presented in “The Next 4 Billion” report. Target population for lighting and electricity To size the market for the lighting and electricity, we apply national-level estimates for urban and rural electrification rates from a number of different sources, including the IEA, UNDP, and national statistics. We also made adjustments to the urban and rural electrification rates with respect to income levels, knowing that these two characteristics are highly correlated. However, data based on both criteria are not widely available for all countries. To estimate electrification rates across income segments for both urban and rural populations, we determined the relationship between these characteristics based on available data and applied an appropriate factor to national urban and rural electrification rates by region and the country’s GDP. 147 CHAPTER 4 APPENDIX Target population for cooking Estimates for improved cooking relied on country-level data compiled by Legros et al. (2009) for the United Nations and the World Health Organization (WHO) report, “The Energy Access Situation in Developing Countries; A Review Focusing on the Least Developed Countries and Sub-Saharan Africa.” For cooking, we also accounted for disparities among different income levels regarding the use of improved cooking fuels. As with electrification, higher-income households are more likely to have access to improved cooking practices. Given the higher cost of improved cooking fuels, we assume that access to these fuels is concentrated at the higher-income populations. Therefore, the estimated proportion of the population using improved cooking fuels is first applied to the highest-income households. This provides a more conservative estimate of the addressable market by filtering out the higher-income households, which might already have access to improved cooking fuels. Scaling up to estimate the world target population The estimates for the target population above relied on the information about the 36 countries presented in “The Next 4 Billion.” To estimate the global market, we used two international sources to provide global estimates. For the lighting and electricity market, the IEA’s estimate in the World Energy Outlook 2009 (IEA 2009) of 1.4 billion unelectrified people is used to define the global market. For the global market for improved cooking, the analysis used an estimate of 2.2 billion people relying on traditional biomass for cooking and without access to improved cookstoves, cited in Legros et al. (2009). The Addressable Market for Modern Energy Products Household spending on lighting and electricity In total, annual global expenditures of unelectrified households on lighting and electricity amount to about $19 billion. If we use the distribution in terms of monthly expenditure of about 274 million unelectrified households per month, it is possible to deduce from this distribution the number of households spending more than a certain amount on lighting and electricity, as in figure A.1. Monthly 20 Expenditures on Lighting and SHS; 48 million people (10 million households) Charging Services 15 Mini-Utilities; 145 million people (29 million households) ($, 2010) Grid Extension; 95 million people (19 million households) Modular SHS 10 86 million households $8.35 430 million people Solar and Rechargeable Lanterns 112 million households $5.47 5 561 million people Subsidized 18 million households $1.24 89 million people 0 0 50 100 150 200 250 300 Cumulative Off-Grid Households (million) Figure A.1: Addressable market for modern energy products and services Source: IEA 2009; IFC-WRI 2007; Legros et al. 2009; Demographic and Health Surveys, ICF Macro, various years; UN 2011; Castalia analysis. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS APPENDIX STORIES? 148 The costs of electricity alternatives Given the expenditure levels shown in figure A.1, which of the unserved households would be better off with commercially provided, modern electric services or products? And what kind of services or products would be relevant to them? To answer these questions, we compare current expenditures Costs ($) Up Front Monthly Levelized Solar lanterns 10–25 0–2 1.24 Solar kits 50–150 1–2 5.47 Solar home systems 150–500 1–2 8.37 Mini-grids 50–300+ >5 8.38 (levelized cost threshold based on $50 up-front cost) Grid extension 500+ >2 8.54 (levelized cost threshold based on $500 up-front cost) Table A.1: Alternative modern lighting and electricity technologies Source: IFC analysis Note: SHS = solar home systems. on traditional lighting and electricity to a range of monthly commercial costs of modern energy alternatives. More precisely, we estimate the levelized monthly commercial cost of modern alternatives, which assumes an even amortization of up-front cost over the life of the product and commercial returns on capital invested (table A.1). Modern energy alternatives can be broadly categorized into three groups with regard to the degree of electrification provided and corresponding monthly cost. The first category, at the lower end of the spectrum of modern energy alternatives, consists of simple solar and rechargeable lanterns. These devices start at an up-front cost of $6 to $20 and can be commercially provided at a levelized monthly cost of around $1.25. The second category starts at a monthly cost of around $5.50. At this level, integrated (“plug-and-play”) solar systems become affordable, which provides a step change in the level of electrification since they power several lights or a small appliance and offer better energy storage. Finally, starting at monthly commercial costs of around $8 to $9, households have access to a range of high-quality modern energy solutions. These comprise a connection to mini-grids or the national grid, where available, and more elaborate, rooftop solar home systems. Table A.1 illustrates this range of solutions and corresponding costs. The indicative cutoff levels used for the market sizing are based on current and commercially viable products in the market. Segmentation of the addressable market along technology categories Combining spending levels with cost ranges, we estimate the commercial access to electricity opportunity. Figure A.2 summarizes the market, which is addressable by each group of technologies. Electricity options at $8.50 a month and above – the addressable market for rooftop solar home systems, utilities, and mini-utilities Fifty-eight million households without access to modern energy spend around $8.50 or more per month on traditional lighting and electricity, for a total of $7 billion a year. These households could potentially afford a range of modern energy solutions. Solar home systems fall into this price range, 149 CHAPTER 4 APPENDIX if financed over the life of the system. So does conventional utility power when people live close to each other and close to an existing grid. Mini-utilities—small isolated electrical generators and distribution grids—can also supply power at about this cost, at least in sufficiently densely populated areas. All these products and services can, at this price, provide good-quality, modern energy that fully substitutes for traditional kerosene lamps, and also provides enough power to run simple appliances like a fan or a radio, and to charge mobile phones. From just the cost and expenditure levels it is not possible to estimate how this segment of the addressable market is subdivided into the three technology categories. However, from a technical and economic perspective, utility grid extension will generally be most competitive in areas close to a grid. Mini-grids will be best in villages that are densely populated but far from a grid, while solar home systems are the fallback option when neither mini-grids nor grid extension is feasible. Applying estimates by the International Energy Agency91 suggests that of the 58 million unelectrified households in the upper segment, 29 million could be served by mini-utilities, 19 million by grid extension, and 10 million by solar home systems. On an aggregate level, this seems to be a fair estimate, while clearly the local competitiveness of different solutions is influenced by regulation and business models. In a competitive market, each technology has the chance to capture a larger share of this “up-market” segment than is noted in figure A.1, or to cede market share to other technologies. Electricity options between $5.50 and $8.50 a month – the addressable market for small and rooftop solar home systems For those households that struggle to afford a utility connection or a conventional solar home system, new kinds of small and integrated “plug-and-play” solar home systems are the most pertinent option. The monthly cost of such systems, assuming a hire-purchase arrangement over the life of the unit at a 30 percent interest rate, is around $5.50. There are around 86 million households spending more than $5.50 and less than $8.50 per month on traditional lighting and electricity. Together, they spend as much as $7 billion per year. These people would enjoy better and more economic service from such systems. Electricity options between $1.25 and $5.50 a month – solar lanterns The price decline in modern lighting devices over recent years means that at least some level of modern energy service can be extended to families spending as little as $1.25 per month on lighting. As many as 112 million households are already spending enough on lighting to potentially benefit from these technologies. The combined spending of this group on lighting and electricity amounts to $4.2 billion per year. Sensitivities The size of the theoretically addressable market and the subset of the likely addressable market depend on many factors. Among the factors examined here are willingness to pay, availability of financing to transform up-front costs into annuity payments over the life of the products considered, commercial prices, interest rates, duties and tariffs, and income levels. Up-front cost matters a lot to the addressable market The addressable market estimates are based on levelized monthly cost. If, instead, customers had to pay all or most of the cost up front, the addressable market would be smaller. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS APPENDIX STORIES? 150 Since poor households are typically capital constrained, with little savings and few opportunities to borrow, households struggle to buy lanterns at the up-front cost of $18, whereas monthly payments of $2 for 36 months would make them widely accessible.92 If finance is not embedded in the business model, the household will have to find a way to cover the up-front cost, and this can create a significant barrier to sales. When departing from levelized cost and introducing up-front elements, we need to account for the customers’ willingness and ability to deal with such cost. Interviews with industry experts suggest that customers decide on purchases of consumer durables, such as solar lanterns or improved cookstoves, based on their expected payback periods. For solar lanterns, three-to-six-month payback periods are generally accepted, while for larger-ticket items, such as integrated and rooftop solar home systems, customers accept payback periods of six months to one year. In the sensitivity analysis in table A.2, it is assumed that solar lanterns have an accepted payback of three months, rooftop solar home systems of nine months, and solar home systems of one year. For example, a family currently spending $2 per month would purchase a solar lantern with total costs of up to $6 in the first three months, including both up-front and ongoing costs. If the solar lantern cost more than $6, the family would not buy it. The results below indicate the impact of up-front costs on the addressable market size. In the case of solar lanterns, a required up-front payment of 10 percent would reduce the addressable market by 13 million households, to 99 million. The results for solar and rechargeable lanterns demonstrate Up-front Cost as Integrated Solar Home Systems Grid Extension Solar Lanterns % of Product that financing and the reduction of the up-front cost are Mini-grids Solar Kits important to increase the size of the likely addressable market. If all lantern consumers had to pay the full cost up front, while solar home systems remained available at levelized cost, the estimated addressable lantern market would be less than 1 million. More realistically, 0%- 112 86 10 29 19 Base however, up-front payments would also apply to other case technologies. This case with up-front cost “across the 10 99 40 3 29 2 board” is illustrated in table A.3. Compared to the base- 20 86 37 2 19 <1 30 63 <1 <1 19 <1 case scenario, this results in a downward migration on the 40 60 <1 <1 18 <1 technology ladder, and the effect on the lantern market 50 36 <1 <1 9 <1 60 22 <1 <1 9 <1 would be less dramatic. Still, the results show that a large 70 8 <1 <1 8 <1 number of potential consumers are squeezed out of the 80 <1 <1 <1 6 <1 90 <1 <1 <1 6 <1 market or into lower technology segments to the degree 100 <1 <1 <1 5 <1 that up-front costs prevail. Table A.2: Sensitivity analysis of up- front payments on the addressable market (millions of households) Source: IFC analysis. 151 CHAPTER 4 APPENDIX The majority of sales today are made on an up-front cash Up-front Cost as Integrated Solar Home Systems Grid Extension Solar Lanterns % of Product basis. The numbers above show the large impact that a Mini-grids Solar Kits higher availability of finance (built into business models or provided to different parts of the value chain) could have on the actually addressable market and the quality of affordable modern energy solutions. If the up-front cost 0%- 112 86 10 29 19 of lanterns is reduced from 100 percent to 50 percent,93 Base the addressable market for solar and rechargeable lanterns case could increase steeply. 10 144 65 3 29 2 20 135 74 2 19 <1 Also, the addressable market for solar kits is highly 30 150 38 <1 19 <1 40 167 17 <1 18 <1 sensitive to financing and reduced up-front payments. In 50 163 8 <1 9 <1 Bangladesh, Grameen Shakti and similar organizations 60 155 2 <1 9 <1 70 148 <1 <1 8 <1 have seen a dramatic increase in their sales in the past 80 141 <1 <1 6 <1 five years by offering their customers three-year financing 90 138 <1 <1 6 <1 100 98 <1 <1 5 <1 with a 20 percent up-front payment. Where financing is unavailable, the markets for solar home systems are much smaller. Solar Energy Uganda is struggling to increase sales Table A.3: Sensitivity analysis of up- and has only a very limited form of financing, offering front payments “across the board” on customers in a savings group six months of financing with a the addressable market (millions of 50 percent up-front payment. The chief executive officer of households) Solar Energy believes that his sales would likely more than Source: IFC analysis. double if he could provide low-interest financing of two to three years to his customers. Lighting Africa estimates that there are only 2.5 million solar home systems installed in Grid Extensionb the world today. Lack of financing in the business models Solar Lanterns % Change in Solar Home Min-gridsa Solar Kits Systems is one reason for the low penetration thus far. Price Sensitivity to price Prices of lighting and electricity technologies are expected +50 99 <1 <1 3 2 to fall with component and manufacturing costs, especially +20 100 40 3 9 6 for solar lanterns, solar kits, and solar home systems.94 The sensitivity analysis in table A.4 illustrates that the sensitivity +10 105 76 6 19 12 of the addressable market to reductions of the levelized 0%- 112 86 10 29 19 Base commercial cost varies along technology segments. While case the price sensitivity of solar and rechargeable lanterns to -10 115 94 16 48 31 changes in the levelized monthly price is small in relative -20 121 110 16 49 32 terms, the other segments are much more responsive. -50 124 163 29 87 57 Analogous to the sensitivity analysis to up-front cost, Table A.4: Sensitivity analysis of table A.5 illustrates price sensitivities to simultaneous price on the addressable market and uniform changes in levelized monthly cost for all (millions of households) technologies (“across the board”). Source: IFC analysis. a. The reduction in price for the mini-grid is a reduction in the monthly ongoing cost of the service, not including the connection fee. b. Reduction in price refers to a reduction in the $500 connection fee, which makes up the majority of the levelized cost of service for grid extension. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS APPENDIX STORIES? 152 Sensitivity to consumers’ willingness to pay Grid Extension Solar Lanterns % Change in and income levels Solar Home Mini-grids Solar Kits Systems Price The assumptions for the market sizing are based on a household’s current expenditure on traditional lighting and electricity. However, there is substantial evidence that unelectrified households are willing +50 184 <1 <1 3 2 to pay more for superior, modern energy services.95 +20 146 40 3 9 6 Assuming an increase in the willingness to pay by +10 115 76 6 19 12 20 percent effectively turns the spending curve up 0%- 112 86 10 29 19 by 20 percent. The same logic applies to variations Base of household income. The sensitivity analysis in table case A.6 illustrates the impact of changes in willingness to -10 107 57 16 48 31 pay or household income of +/-20 percent on the size -20 97 70 16 49 32 of the addressable market. -50 47 48 29 87 57 Willingness to pay and income are important drivers Table A.5: Sensitivity analysis of of the size of the addressable market. The largest price “across the board” on the impacts are for more expensive products and services, addressable market (millions of such as solar home systems and mini-utilities. An households) increase in the willingness to pay for solar home Source: IFC analysis. systems can increase the addressable market by roughly 60 percent. Growth in the lighting plus market pay as % of base Grid Extension Solar Lanterns Willingness to The IEA96 predicts the unelectrified population Solar Home Mini-grids Solar Kits Systems will decline by only 2 percent in their New Policies Scenario (which describes the business-as-usual case), falling to 1.2 billion people by 2030. Asia and Latin America will both experience an increase in their electrification rates, while in Sub-Saharan 120 121 99 16 49 32 Africa, the population without access to electricity 110 115 88 16 48 31 will continue to grow. To estimate the addressable 100%- 112 86 10 29 19 Base market for lighting and electricity in 2030, the IEA case projections are applied to the market size model. If 90 101 43 6 19 12 real incomes of the unelectrified households were to 80 99 40 3 8 5 remain constant to 2030, the net effect of the higher electrification rate would shrink the addressable Table A.6: Sensitivity analysis of market for lighting and electricity by 48 million willingness to pay for electricity on households, or about 20 percent. the addressable market (millions of households) Source: IFC analysis. 153 CHAPTER 4 APPENDIX However, the assumption that household incomes will remain constant over the next 20 years is unrealistic and, in reality, they will likely grow significantly. In the sensitivity analysis in table A.7, different scenarios are presented for changes in household incomes. If household incomes of the unelectrified population grow by 20 percent in 2030, the market shifts toward solar home systems, mini-grids, and grid extension, which hold Income as % Change in House- would comprise 24 percent of the total addressable Grid Extension Solar Lanterns Solar Home market. Our population growth analysis measures Mini-grids Solar Kits Systems of Base only the number of households that still rely entirely on traditional energy. It is simplistic in that it does not account for replacement business from the newly electrified households until 2030. 120 120 45 9 26 17 Addressable market for improved 110 129 34 8 25 16 cookstoves and fuels 100%- 127 52 5 15 10 Base Around 2.5 billion people,97 or about 425 million case households worldwide, cook with traditional solid 90 133 36 3 10 6 biomass burned in simple stoves and fires. These 80 135 42 2 5 3 households spend around $19 billion per year Table A.7: Sensitivity analysis of globally—mainly on wood and charcoal. How household incomes on the addressable many of them could afford improved cookstoves market in 2030 (millions of that would burn more efficiently and produce less households) harmful smoke? How many could afford improved Source: IFC analysis. fuels, such as biomass pellets or liquefied petroleum gas? As for the addressable market for electricity, the approach taken is based on current spending levels on traditional cooking energy and derives from this data how many households could afford improved cookstoves or fuels. Household expenditure on wood and charcoal The market for traditional cooking fuel is broadly broken into two segments, charcoal and wood. Charcoal is mainly used by urban households and traded on a cash basis. Wood, however, is much more common among rural households. Rural households collect much of the wood burned themselves. This takes time but does not have a cash cost. Some wood is bought from others, however. For the purpose of this market sizing analysis, only cash purchases are considered as expenditure. While it often takes a significant amount of time to collect fuel wood, this time cannot be easily converted into cash; therefore, it is difficult to assume it could be diverted to purchasing improved cooking devices. The cost of improved stoves and fuels Prices of improved cookstoves in the market today can vary substantially according to where they are manufactured and their level of technological sophistication. Improved cookstoves using enhanced biomass will cost a family around $9 per month or more (including fuel costs). Improved cookstoves based on existing fuels, such as wood and charcoal, have a minimum cost of around $7 and can save a family 30 to 40 percent per month in cooking fuels (table A.8). WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS APPENDIX STORIES? 154 Costs($) Up Front Ongoing Levelized Fuel Saving Advanced fuels $20–$100 >$2 $8.95 n.a. Improved charcoal stove $5–$25 n.a. $0.38 29% Improved wood stove $5–$50 n.a. $0.38 43% Table A.8: Improved cooking devices Source: IFC analysis. Note: n.a. = not applicable. Figures A.2 and A.3 show the estimates for the total addressable market for improved fuels and improved cookstoves in both the charcoal and wood cooking markets. In summary: • 20 million households are already spending $9 or more per month on wood and charcoal for cooking. These households could afford to switch to improved fuels. • 374 million households would be better served with improved cookstoves based on their expected fuels savings (above $0.90 for wood, above $1.30 for charcoal, and below $9).98 Monthly Expenditures on Charcoal ($, 2010) 20 15 Alternative Fuels 19 million households 93 million people 10 Improved Charcoal Cookstoves $8.95 63 million households 313 million people 5 Subsidized 2 million households $1.30 10 million people 0 0 10 20 30 40 50 60 70 80 90 Cumulative Charcoal-Using Households (million) Figure A.2: Addressable market for improved cooking – charcoal Sources: Based on the distribution of household expenditure on charcoal and wood in IFC-WRI 2007; Demographic and Health Surveys, ICF Macro, various years; National Sample Survey Office, India 2005; UNDP/WHO 2009; and Castalia analysis. Monthly Expenditures on Wood ($, 2010) 20 15 Alternative Fuels 1 million households $8.95 6 million people 10 Improved Wood Cookstoves 311 million households 1,553 million people 5 Subsidized 30 million households $0.89 151 million people 0 0 50 100 150 200 250 300 350 400 Cumulative Wood-Using Households (million) Figure A.3: Addressable market for improved cooking – wood Source: IFC analysis. 155 CHAPTER 4 APPENDIX Cooking for over $9 per month – the addressable market for modern improved cooking fuels Households spending over $9 on traditional biomass for cooking have the potential to switch to a modern, more advanced fuel. These fuels include new technologies that turn agricultural waste into biomass pellets, charcoal-dust, and liquid fuels, and also more established modern fuels, such as liquefied petroleum gas. Additional benefits from switching to an improved fuel for cooking not only include improved health impacts, but these technologies often have reduced cooking times and less impact on the environment. Cooking for ~$1 to $9 per month – the addressable market for improved wood and charcoal cookstoves Households that are spending $.90 for wood or $1.30 for charcoal, and up to $8.95 per month, could afford to purchase an improved cookstove based on the expected fuel savings over the product’s life. The lowest-cost improved cookstoves on the market today are about $7 and can save a family at least 30 percent in charcoal over traditional cookstoves, or 40 percent in wood over a three-stone fire. The estimate of the addressable market for improved cookstoves is based on the expected monthly fuel savings per family. If these savings are greater than or equal to the monthly cost of the cookstove,99 the household would benefit from purchasing an improved cookstove. The monthly capital cost for a $7 cookstove is $0.38. This capital cost would be more than compensated by fuel savings at monthly expenditures on charcoal of at least $1.30, or $0.90 on wood. As for the electricity market, this is a theoretically addressable market, since certain segments of this market will be foreclosed by local cooking practices that are incompatible with standard improved cookstoves or modern fuel devices. Also, the decision to purchase a cookstove is not entirely based on fuel savings. While savings remain the first priority of many poor households, design elements such as portability, ease of use, and cooking time are also important factors that influence willingness to pay. The effect of financing constraints, resulting in higher up-front costs, or variations in willingness to pay, can be seen in the following sensitivity analysis. Sensitivities of the addressable market for improved cookstoves and fuels Analogous to the electricity section, this section analyzes the sensitivity of the addressable market estimates to up-front cost, to the price of the product, to incomes or willingness to pay, and to future scenarios. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS APPENDIX STORIES? 156 Up-front payments matters a lot for the addressable market The estimated size of the addressable market is based on the levelized monthly costs of a cookstove compared to expected monthly fuels savings. Purchasing a cookstove in one up-front payment would present a financial hurdle for many poor households and reduce the size of the addressable market. Cookstove companies are aware of this sensitivity and have devised different ways to reduce the up-front costs of a stove. When compared to modern energy technologies, households generally expect a shorter payback for improved cookstoves due to shorter expected life, and because most benefits of improved cooking are not immediately tangible. Experts in the field and companies report a generally accepted payback period of one to three months on an improved cookstove. The sensitivity analysis below estimates the impact of higher up-front payments on the addressable market for improved cooking based on a three-month simple payback through fuel savings. For example, the 10 percent up-front cost case indicates that 60 million households would purchase an improved charcoal cookstove with a 10 percent up-front payment and financed over the life of the product with an annual interest rate of 30 percent. If financing is available, over 90 percent of households using traditional biomass for cooking could access improved cookstoves and improved fuels. The remaining households have so little cash expenditures on traditional cooking fuels that improved cookstoves and fuels would not amortize in terms of cash savings. Up-front costs have a large impact on the market size. The addressable market for improved cookstoves quadruples when the up-front payment is reduced from 100 percent to 50 percent of the total cost of the stove (table A.9). As illustrated in the market of lighting and electricity, the result of the up-front payment sensitivity changes when applied “across the board.” The result would be a smaller overall addressable market that will be dominated by improved cookstoves (table A.10). Improved Cook Improved Cook Improved Fuels Improved Fuels Up-front Cost Up-front Cost Product Cost Product Cost as % of as % of Stoves Stoves 0%- 373 20 0%- 373 20 Base Base case case 10 355 9 10 366 9 20 317 6 20 331 6 30 296 3 30 312 3 40 228 1 40 247 1 50 162 <1 50 182 <1 60 114 <1 60 134 <1 70 72 <1 70 92 <1 80 57 <1 80 77 <1 90 49 <1 90 69 <1 100 40 <1 100 60 <1 Table A.9: Sensitivity analysis of Table A.10 Sensitivity analysis of up-front payment on addressable up-front payment on addressable market for improved cooking market for improved cooking (millions of households) – across the board (millions of Source: IFC analysis. households) Source: IFC analysis. 157 CHAPTER 4 APPENDIX Price The impact of price (in terms of levelized commercial cost) on the addressable market for improved cookstoves is small. Further declines in the price will have only small impacts on this segment of the addressable market because there are relatively few households spending less than $0.38 per month. For improved fuels, at a levelized monthly cost of $8.95, the price elasticity of the spending curve is higher. Hence, price reductions have a greater impact on the market for improved fuels. Going forward, prices of improved cookstoves and fuels could potentially decline, especially if companies succeed in leveraging carbon credits. Locally produced cookstoves in Ghana and Mali have already passed the rigorous application and verification process to obtain carbon credits and are now beginning to receive carbon payments. This will have an impact on the addressable market to the extent that it lowers the up-front price component (see table A.10), and to a lesser extent through the reduction of levelized cost (table A.11). As for modern electricity products and services, the results change when we apply the sensitivities across the board and the market shifts toward improved fuels. Willingness to pay or income levels The assumptions for the market sizing are based on a household’s current expenditure on cooking. The sensitivity analysis below illustrates the impact of changes in willingness to pay and income levels (which are assumed to have a proportional effect on willingness to spend) on the addressable market. Similar to the results of the sensitivity analysis for the impact of price on the addressable market, willingness to pay also has a strong effect on the market for improved fuels (table A.13). Customers have demonstrated a higher willingness to pay for modern improved fuels, such as liquefied petroleum gas, because it often an aspiration for many middle-income families. Growth in the cooking market The IEA100 estimates that by 2030, the population relying on traditional biomass without improved cooking practices will grow by 3 percent. The growth in the unserved population will be concentrated in lower-income countries, especially in Sub-Saharan Africa. As a result, the base case scenario of constant income levels estimates that the overall market for improved cookstoves is almost unchanged, while the market for improved fuels is expected to decline. Changes in household incomes will have an impact on the size and composition of the addressable market. If household incomes grow, the market in 2030 for improved cooking will shift toward improved fuels. If household incomes fall, improved cookstoves will remain the most economically viable choice for the majority of the addressable market (table A.14). WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS APPENDIX STORIES? 158 Improved Cook Price Reduction Improved Cook Improved Fuels Improved Fuels % Change in from Current Stoves Stoves Price Price +50 355 <1 +50 375 <1 +20 372 6 +20 386 6 +10 372 9 +10 383 9 0%- 373 20 0%- 373 20 Base Base case case -10 380 35 -10 364 35 -20 387 48 -20 360 48 -50 397 97 -50 320 97 Table A.11: Sensitivity analysis of Table A.12: Sensitivity analysis of price on addressable market for price on addressable market for improved cooking (millions of improved cooking – across the households) board (millions of households) Source: IFC analysis. Source: IFC analysis. hold Income as % Change in House- Improved Cook Improved Fuels Willingness to Improved Cook Improved Fuels Pay as % of Stoves of Base Stoves Base 120 354 46 120 360 32 110 365 35 110 369 22 100%- 373 20 Base 100%- 375 13 case Base case 90 383 9 90 378 6 80 386 3 80 378 2 Table A.13 Sensitivity of Table A.14 Sensitivity analysis willingness to pay and income of household incomes on the levels on the addressable market Source: IFC analysis. addressable market in 2030 (millions of households) Source: IFC analysis. 159 CHAPTER 4 APPENDIX Appendix B: Socioeconomic Impact of Serving the Energy-Poor Estimates of socioeconomic impact are calculated based on serving the entire addressable market for lighting and electricity and cooking (tables B.1 and B.2). For lighting and electricity, the benefits are calculated for replacing kerosene lamps. We assume that solar lanterns replace one kerosene lamp per household and all other technologies replace three kerosene lamps. For estimates of the health benefits, kerosene lamps are assumed to release one-fifth of the harmful particulate matter of traditional cookstoves and therefore contribute to one-fifth of the negative health impacts. We assume kerosene lamps will emit 100 kilograms of carbon each year, and the net carbon emission reductions account for this reduction plus the carbon emitted from each improved lighting and electricity technology. Annual Sick Time Kerosene Annual GHG Families Avoided Annual Lamps Reductions Served (Days, Deaths Replaced (kg-CO2e, Lighting (millions) millions) Avoided (millions) millions) Grid extension 20 2 6,638 60 — Mini-grids 29 3 9,625 87 3,480 SHS 10 1 3,319 30 2,634 Integrated SHS 86 9 28,543 258 23,914 Solar lanterns 112 12 37,172 112 9,520 Total 257 27 85,296 547 39,547  Table B.1: Health and environmental benefits of modern lighting solutions Sources: ECN 2006; IFPRI 2006; Mills 2005; Poppendieck et al. 2010; WHO 2006; World Bank 2006; interviews with industry experts and companies. Note: — = not available. CO2e = carbon dioxide equivalent; GHG = greenhouse gas; kg = kilogram. Annual Sick Time Annual GHG Families Avoided Annual Reductions Served (Days, Deaths (kg-CO2e, Cooking (millions) millions) Avoided millions) Improved charcoal 63 33 104,545 39,602 Improved wood 311 164 516,089 195,497 Improved fuels 20 30 93,329 24,062 Total 394 227 713,964 259,161 Table B.2: Health and environmental benefits of improved cooking solutions Sources: ECN 2006; IFPRI 2006; Mills 2005; Poppendieck et al. 2010; WHO 2006; World Bank 2006; interviews with industry experts and companies. Note: CO2e = carbon dioxide equivalent; GHG = greenhouse gas; kg = kilogram. WHAT CAN BE DONE TO HELP SCALE UP ENERGY ACCESS SUCCESS APPENDIX STORIES? 160 Appendix C: How Mini-Utilities Grow into Big Utilities Utility Year Current Customers Growth History Mini- Equity Utility Value ($ Founded millions)a Con Edison Con Edison 1882 14,600 3,000,000 Established in 1882, Thomas Edison’s Pearl Street Station was the first (Consolidated (Consolidated centralized power plant in the United States. It initially served 85 Edison), Edison), United customers who had less than five lamps each. Overcoming competition States States United that provided traditional fuels, the system expanded rapidly. Two years later, the system had expanded to serve 508 customers with a total of over 10,000 light bulbs. Due to organic growth and an aggressive rollout strategy, the company grew rapidly beyond its initial local market in Manhattan. Its successor company has an equity value of over $14 billion. JPSCo (Jamaica JPSCo 1892 400 600,000 By 1892, Kingston, Jamaica had a public power supply. JPSCo—privately (Jamaica Service Public Public owned and established in 1923 with 4,000 customers—gradually bought Company), Service Company), small systems, completing consolidation in 1945. JPSCo (once again Jamaica Jamaica private after a period of public ownership) now serves 98 percent of the Jamaican population. It is owned 40 percent by Marubeni, 40 percent by East West Power, and 20 percent by the Government of Jamaica. Meralco, Meralco, 1895 6,594 20,000,000 “La Electricista” started supplying power in the Manila area in 1895. By Philippines Philippines 1903, it had 3,000 customers. This operation was later absorbed into other electricity providers in the Manila area, helping create Meralco, the private utility that now supplies around 20 million people, with an electrification rate of 97 percent. CEPALCO CEPALCO 1952 N/A 100,000 CEPALCO is an electric distribution utility serving the City of Cagyan de (Cagayan Electric Oro and the surrounding municipalities in the Philippines. It began Electric Power and Power Light operations in 1952 with 750 customers and now has over 100,000. Company),Light and Company), Philippines Philippines NDPL (North NDPL (North 1905 300 1,200,000 In 1905, a private company set up a 2-megawatt diesel station set at Power Delhi Power Ltd.), Lahori Gate in Old Delhi, supplying the city with power for the first India India Ltd.), time. Development of the power supply continued in the Delhi area under a number of private and public companies. However, starting in 1932, the tendency was toward consolidation under public ownership, and this seems to have been completed in 1947. Service and financial performance deteriorated over the years, and the entire system was reprivatized in three companies (of which NDPL is one) in 2002. LUCELEC LUCELEC 1965 60 60,000 Before 1965, the only power supply on St. Lucia was from very small, (St. Lucia Electricity mostly government-owned systems. Electricity connections on the island (St. Lucia totaled only around 4,000, for a population of about 96,000. To expand Services Limited), Electricity access, the government reached an agreement with the Commonwealth St. Lucia Services Development Corporation. CDC created LUCELEC, which took over Limited), St. the dispersed government system and started building a grid that would Lucia eventually serve the entire island. By 1985, the company had 18,000 customer connections. Today, St. Lucia has nearly 100 percent electrification with nearly 60,000 customer accounts islandwide. Note: 119 Book Book a. value value of of2010 equity, equity as reported fi nancial in 2010 financial statements. statements 161 CHAPTER 4 APPENDIX Appendix D: Grid Extension – Recent Relaxation of Exclusive Arrangements Country Previous Regulatory Position New Regulatory Position India Since 1948, the dominant model was monopoly The Electricity Act of 2003 addressed power sector supply by Electricity Boards owned by state liberalization and rural electrification, removing governments and granted exclusive statewide licensing and exclusivity arrangements for rural franchises. Some preexisting large private utilities electrification. Proviso 8 in Section 14 states that a were allowed to operate. The governing legislation license is not needed to generate and distribute was the Electricity Supply Act of 1948 and various electricity in rural areas. However, the distributor is still state-level laws. required to comply with the safety provisions of the act. Nigeria In 1972, the National Electric Power Authority In 1998, amendments to the Electricity Act removed (NEPA) was created by statute as the result of a NEPA’s monopoly powers. To date, much of the new merger between the Electricity Company of entry has occurred in generation to supply the grid, as Nigeria and the Niger Dams Authority. A captive power/self-generation. vertically integrated utility, NEPA was granted monopoly powers by statute. Philippines Exclusive distribution franchises that together In 2001, the Electric Power Industry Reform Act covered the entire country have been awarded by (EPIRA) made it possible for the Energy Regulatory Congress. Commission (ERC) to give permission to “Qualified Third Parties” to supply power in franchise areas where the incumbent was not supplying power. In 2006, the ERC promulgated a set of Implementing Rules and Regulations governing the process. Rwanda Electrogaz was established in 1976 by Organic In 2011, a new Electricity Law was passed by Law 18.76 as the state-owned monopoly Parliament, and enacted into law in July of that year. distributor of water and electricity in Rwanda. Article 7 of the law requires anyone engaged in Restructuring and private participation followed electricity distribution to obtain a license from the from 1999. However, Electrogaz remained the regulator. Article 26 provides that the regulator may monopoly distributor. create simplified licensing procedures for isolated systems in designated rural areas, or waive the need for licenses for companies operating under contract from the Energy Water and Sanitation Authority (an entity that can plan and fund rural electrification). The law further provides that anyone who supplies power without a license may be imprisoned for up to three years (Article 50). Tanzania The state-owned utility Tanesco operated under In 2008, a new Electricity Act was passed. Section 8 an exclusive license granted by the government stipulates that licenses are required for electricity under the Electricity Ordinance 1957. distribution, and anyone distributing power without a license may be imprisoned for up to five years. Licenses may be exclusive or nonexclusive. Section 18 provides that off-grid distributors in rural areas serving a peak demand of less than 1 megawatt do not need a license. The regulator, may, nevertheless make rules governing such systems.  PHOTO CREDITS 162 Appendix E: Photo Credits Photo Credits Page Barefoot Power 41 Batdeong 74 Bonny Utility Company 84 Castalia 81 d.light 41 Duron 41 Envirofit 46, 69 Fenix 53 First Energy 29, 46 Greenlight Planet 29, 41, 65 Hans de Keulenaer 105 Husk Power Systems 85 IFC 1, 6, 11, 20, 21, 29, 49, 54, 96, 117, 124, 130, 134 Jiko 46 Kamworks 41 Katene Kadji 46 Nuru Light 55 Pepukaye Bardouille 48, 59 SELCO 41 SETAR 37 Sundaya 29, 41 Sunlabob 41, 57 Tecnosol 41 Terrestrial 27, 29, 40, 113 Toyola 46 Ugastove 46 163 NOTES Notes 1 17 Double bottom line companies are companies that expect The Director for Central Africa Market Development, both a financial and a social return. Unilever. 18 2 The campaign took place in the province of Mwanza with For example, UNDP 1997; and UN-Energy/AGECC 2011. a budget of around $500,000. It included building awareness 3 with key decision makers. For example, Bazilian et al. 2011. 19 4 www.lightingafrica.org. IEA 2011. 20 Several device companies, across technologies—including 5 Flows from members of the Development Assistance SELCO, Tecnosol, and Toyola—are investees in an investment Committee (DAC) of the Organisation for Economic Co- fund, which, in turn, receives financing from a range of operation and Development. development institutions, including IFC. The private sector 6 arms of some donor institutions might also invest directly in This $37 billion spent annually on energy services by businesses. For instance, in 2011, the Norwegian Development households without access to modern solutions should not be Agency made a $5.5 million investment in lighting device confused with the International Energy Agency’s 2010 estimate supplier, ToughStuff. of $36 billion in annual investment needed to achieve universal 21 energy access by 2030 (IEA 2010). The amounts are similar, In 2007, the AMS II.G (Clean Development Mechanism [CDM] methodology on energy efficiency measures in thermal but they refer to different aspects of energy access. applications of nonrenewable biomass) was approved as part 7 of the CDM of the United Nations Framework Convention Lighting Africa Research, www.lightingafrica.org. on Climate Change). AMS II.G was the first small-scale 8 methodology to assess baseline and monitoring for activities IFC-WRI 2007, adjusted to only account for cash expenditures. promoting energy efficiency in biomass use. CDM is a mechanism that commoditizes or monetizes carbon reductions 9 A 30 percent interest rate is used for this calculation, which in developing countries—which are, in turn, accounted is a rate typically faced by poor people in developing countries. through national and United Nations Framework Convention Estimates of the addressable market are not based on the on Climate Change greenhouse-gas registries to be purchased assumption that finance is available for free or at low rates. by developed-country markets such as the European Union Rather, the estimates assume that the business model used to (European Union Emissions Trading System, EU ETS)—to sell the product or service embodies a way for the supplier, or a meet national greenhouse-gas reduction targets. related financing institution, to embed financing in the product 22 GIZ 2011, 5. offering. Capital costs are recovered with commercial interest, 23 but the up-front payment is removed and replaced with a level Toyola’s process for Voluntary Gold Standard registration stream of monthly payments. started in 2007. 24 10 The Paradigm Project, headquartered in the United States Also called an installment plan, closed-end leasing, or rent with operations in Kenya, is leveraging carbon offsets through to own. the voluntary Gold Standard to finance sustainable cookstove 11 businesses in the developing world. This financing approach GSMA 2010. helps attract investment for project start-up costs and helps 12 reduce the cost of the stove to end users from an average of Watts peak is a measure of the nominal power of a photovoltaic solar energy device. $35 to an average of $15, a price that helps overcome barriers to clean energy access for the poor. Through this model, 13 According to research from the IFC Lighting Africa Team. Paradigm was able to sell nearly 40,000 stoves in its first full year of operation and forward sell over 125,000 tons of offsets 14 Funds from the University of Colorado and the Bohemian to a nonprofit buyer in the Netherlands. and Shell Foundations. 25 GIZ 2011, 6. 15 Lighting Africa 2010. 26 Haigler et al. 2010. This figure is reasonable if the CDM 16 IFC 2007. mechanism or something similar continues. Gold Standard NOTES 164 Carbon Credits may sell for less than this, perhaps around $5. specific factors, notably the cost of generation by the mini- 27 utility, the quality of the solar resource powering a solar home Programmatic CDM is also called a program of activities system, and the cost per kilometer of erecting distribution (PoA). This is a voluntary action undertaken by a private or lines. Other factors, like the diversity of load profile in the area public entity that coordinates and implements any policy, served, can also come into it. measure, or stated goal (that is, incentive schemes and voluntary 41 programs), which leads to greenhouse gas emission reductions The nonprofit arm is DESI Management Training Centre for that are additional to any that would occur in the absence of Rural Women, or Mantra, and the loan provider is Baharbari the PoA. Odhyogik Vikash Sahkari Samiti. 28 42 Wurster 2011. Feed-in tariffs are a policy mechanism used in a number 29 of countries to accelerate investment in renewable energy 1,000 kW = 1 MW. technologies by offering power producers long-term supply 30 This differs from independent or merchant power producers, contracts, generally reflecting the technology-specific cost of which feed power into the grid using an offtake agreement with generation. the incumbent utility, supply large customers through bilateral 43 IFMR 2010. arrangements, or generate power for their own consumption. 44 31 Baker 2009, 18. Used broadly to describe the shift, as incomes rise and 45 preferences change, to increasingly efficient and less directly While there are a few examples of mini-utilities leveraging polluting energy carriers and conversion devices. For cooking carbon finance, these are limited, and therefore will not be and heating, the steps rise from dung or crop residues to fuel discussed here. wood, charcoal, kerosene, and liquefied petroleum gas, natural 46 Castalia research for World Bank. gas, or electricity. In the case of lighting, the steps are initially 47 fire then kerosene or candles and then electric bulbs. Jadresic 2000. 32 48 Since the report does not consider the additional restriction The arguments in this section are based, in part, on Ehrhardt of load density, but only income levels. and Burdon 1999. 33 49 Micro hydro is a type of hydroelectric power that typically State governments specify which parts of the state are to be produces up to 100 kW of electricity using the natural flow of classified as rural for these purposes. water. 50 Baker 2009. 34 According to interviews with three mini-utility companies. 51 Marboeuf 2009. 35 Three-phase electric power, the most common method 52 This later resulted in significant overcapacity. These used by grids worldwide to transfer power, is a method of circumstances reversed dramatically under different leadership alternating current electric power generation, transmission, and a decade later, leading to rolling blackouts. But due to the bulky distribution. nature of power generation investments and lag times in new 36 Electricité de France and Total sold their shares to RESCO capacity coming online, such dynamics are, unfortunately, employees in 1999. widespread. 37 53 UNDP 2011. Ampla’s initiative has won multiple prizes, including “Best 38 International Metering Initiative” in 2006. IFMR 2010. 39 54 Silica and rice husk char are by-products of HPS’s operations. The company offers basic life insurance to families that Rice husk char can be compressed into incense sticks. remain current with their bills. This is valued by customers 40 because life insurance is otherwise not available in these As the distance between customers increases, the cost of communities, and the loss of a breadwinner can leave a family distributing power to each user rises (because more investment destitute. NDPL is able to create a risk pool that is insurable and in wires and poles is needed), and at a certain point the additional to provide a low-cost distribution mechanism for the families. cost of distribution starts to exceed the cost advantage that the The company pays the premium to keep the insurance current mini-utility has in generation. The crossover point between the so long as their bill is paid. This creates a strong incentive for costs of the different technologies depends on many location- families to pay their bills, since there is no other way to obtain 165 NOTES or maintain life insurance. 64 Return on equity figures were not available. 55 IFC 2010, 46. 65 Jadresic 2000. 56 World Bank 2011. 66 In a competitive situation, the subsidy required should be 57 no more than the gap between the (present value of) returns Smith 1995, 48–9. expected on the area and the returns required for commercial 58 viability. This kind of output-based plan can also be referred Majority owned by WRB Enterprises of Florida, DOMLEC was established in 1949 as a private company and has grown to as “Viability Gap Financing,” since the government puts to serve nearly 100 percent of the population, using a mix in only the minimum amount of grant finance needed to fill of hydro- and oil-based thermal plants. In 2009, it earned the gap between the expected returns and commercially viable revenues of $76.8 million and has averaged above a 5 percent returns. Both Output-Based Aid and Viability Gap Financing return on assets over the last five years. fall into the broad category of Results-Based Financing. 59 67 The utility is regulated by the Energy Regulatory ONE will operate the concession through a special purpose Commission, which has traditionally operated on a U.S.-style, company known as Comasel de St. Louis, a new company set cost-plus regulatory plan, in which tariffs are adjusted only up specifically for the purpose, under a 25-year concession. The when the utility so requests. The dynamic in the Philippines company is a wholly owned subsidiary of ONE, the Moroccan under this regime has been that companies that grow quickly electricity utility. Comasel’s target for equity returns is in do well—since the reductions in cost from growing economies the mid-teens. It is expected that the first customers will be of scale can outstrip cost increases from inflation, allowing supplied during 2012, after some contractual issues have been companies to earn attractive rates of return. It thus seems resolved with the regulator. likely that a strategy to promote rapid growth will contribute to 68 higher returns on investment for the company. Gassner, Popov, and Pushak 2009. 60 69 Codensa emerged from the 1997 unbundling and For information on Dialog and Idea Cellular, see IFC 2010. privatization of the public utility and has extended electrification 70 in its area to 99.98 percent. UNELCO serves Port Vila (the capital); Luganville, part of the island of Tanna; and part of the island of Malekula. The 61 company was founded in 1945, and has been privately operated Another relevant point for the Codensa Hogar model is that the utility also has the financial strength and reliable brand and profitable throughout that time; in recent years, it earned a name needed to encourage merchants to accept its card. return on equity invested of over 20 percent. 62 71 The source for statements about government motivation is In the Philippines, utilities from the smallest rural a Castalia interview with a member of the Privatization Task cooperative to huge enterprises like MERALCO have been Force. The information presented on North Delhi Power Ltd. granted franchises by the Philippine Congress. No utility was kindly supplied by the senior management team of the is allowed to serve outside its franchise area. MERALCO is utility in a half-day interview at the company headquarters the Philippines’s largest electric power distributor. It supplies in Delhi, and supporting documentation provided by the around 5 million customers, with an electrification rate in its company. franchise area of 97 percent. An estimated 20 to 25 percent of Filipinos are without power supply. Some of these could be 63 commercially served by utility grids, but neither MERALCO That is, $80 million from the initial cash equity investment, $210 million in retained earnings, and $320 million in bank nor any other utility is allowed to extend service to unserved debt. Major lenders include IDBI (Industrial Development customers if they lie outside its franchise area. Bank of India), IDFC (Infrastructure Development Finance 72 Company Limited), and the State Bank of India. Return on IFC 2010, 9–10. equity from 2002 to 2010 was around 21 percent on capital 73 invested. CEMAR, the previously state-owned utility, was privatized in 2000. The utility was bought by its current owners, GP Investimentos, in 2004, and since then it has provided NOTES 166 electricity to over 500,000 new customers. A universal due diligence. electrification program, Luz para Todos, was a key driver, but 82 so was the company’s own ability to improve management Through a certification by Det Norske Veritas, DESI Power efficiency and attract capital. In part because of this expansion has been able to validate its project plans as per the United of access, CEMAR has achieved an annual average growth in Nations Framework Convention on Climate Change criteria, revenue of 12 percent, and a margin of around 40 percent on it and carbon credits equivalent to 5.15 MW of power generation earnings before interest, taxes, depreciation, and amortization. have been sold in advance (Intellecap/IFC-Lighting Asia). 74 83 GSMA 2010b. Of both CDM and Gold Standard CERs (Certified 75 Emission Reductions). As asserted in Tenenbaum (2006), the two golden rules for regulation should be that (a) regulation is a means to an 84 The Global Energy Entrepreneurship Program intends to end. What ultimately matters are outcomes (sustainable launch an Energy Enterprise Portal to help connect potential electrification) not regulatory rules; and (b) the benefits of investors to early-stage funding deal opportunities. regulation must exceed the costs. The economics of off-grid electrification are fragile, with the most expensive electricity 85 The network has ambitious plans to create over 2,400 being “no electricity.” enterprises, generate 240,000 direct and indirect jobs, install 76 3,000 MW of off-grid energy capacity, provide energy access to Reiche, Tenenbaum, and Torres de Mästle 2006. 77 over 28 million people, deliver clean water to over 10 million Castalia research funded by the World Bank. households, and mitigate 65 million tons of carbon dioxide. 78 The first center in Kenya, which secured $15 million in Gassner, Popov, and Pushak 2009. funding, was launched in 2011. 79 Concessional financing typically refers to financing which, 86 compared with commercial terms, provides a subsidy. This Dasra, a nonprofit funded entirely by grants, works with subsidy can be in the form of a low interest rate, a long tenure, philanthropists, corporate foundations, and the government to a subordination, or a grant. (“Subordination” refers to the pool and structure capital to meet their needs. It also serves priority in which financial returns are redistributed to investors as a conduit for eager impact investors, using its research arm in a company or project. Typically, senior debt gets paid back and strong local networks to identify high-potential investees first, subordinated debt gets paid back next, and then holders and document their business models. From that knowledge of a company’s or project’s equity, the highest risk category in base, they pick companies that move into what is termed their a capital structure, would see returns from their investment.) “portfolio.” These portfolio businesses benefit from an intense Concessional financing takes the brunt of the risk and, as such, nine-month executive education program (which brings aims to incentivize investors and banks to support an asset class together 20 social businesses and 20 nonprofit organizations that otherwise has no or limited access to financing. It is used in an attempt to cross-pollinate the two categories) that builds to help design and test innovative business models (not just investment readiness, develops and articulates business plans technologies), and to take them to proof of concept. At that and a compelling growth story, and details their fundamental stage, commercial capital can come in. The concessionality is operating approach. Dasra helped Husk Power Systems raise typically provided by philanthropic donors, governments, its first round of equity, and has also been involved in d.light’s international development institutions, or double bottom fund-raising efforts. line investors, either directly or in cooperation with other 87 The focus has often been on cooking—SNV (the Dutch development finance or commercial institutions. international nonprofit organization) on biogas, GTZ and 80 Mezzanine financing is part of the capital structure, USAID on improved cookstoves, and DfID on indoor air typically convertible equity or subordinated debt, which has pollution, for example. characteristics of both equity and debt. It is subordinate to 88 senior debt but senior to the equity. For instance, until recently, there was very little data on kerosene spend in East Africa and, therefore, limited interest in 81 The arrangement would in addition be backed by several alternatives. Data provision attracted market entrants. Another other financial covenants to align the interests between the case showed that low quality solar lanterns have spoiled consumer bank as lender and IFC, which assumes the project risk without confidence in many markets. These data, which have enabled the 167 NOTES development of national level initiatives involving both business 94 Lighting Africa 2010. and public sector entities, would probably not have been generated without donor supported programs. The same is true for mini- 95 World Bank 2007. utilities. Without basic mappings of both renewable energy 96 (hydro resources, biomass availability, solar irradiation and wind IEA/OECD 2010. speeds) and a detailed understanding of demand centers, mini- 97 utility developers will struggle to build businesses. UNDP/WHO 2009. 89 98 The addressable market is not the maximum market size. The threshold for charcoal-fueled cookstoves ($1.30 per Rather, calculations for estimating the size of the addressable month) is higher than the one for wood ($0.90 per month) market are based on a mix of conservative and more aggressive because the efficiency gains are higher for wood. As a assumptions. Equalizing willingness to spend with current consequence, fuel savings are higher for wood, and cookstoves spending on primitive energy (not increasing it for better service amortize faster. Improved cookstoves achieve fuel economies levels) is conservative; using levelized cost is more aggressive. of 30 to 60 percent over traditional charcoal stoves, and they achieve 40 to 80 percent for wood. For the purposes of the 90 Household Consumer Expenditure in India 2007–2008, market size methodology, 30 percent is used as a conservative National Sample Survey Office India, 2008. estimate for charcoal and 40 percent for wood. These differences are linked to the fuel used and not to technical 91 The market size model used estimates of the breakdown differences between improved charcoal and wood stoves, which between grid access, mini-grid, and off-grid energy solutions have the same capital cost. to meet the target in the Universal Modern Energy Access 99 Case presented by the IEA in IEA (2010). The Universal Assuming financing over the life of the stove, with a 30 Modern Energy Access Case quantifies a scenario in which percent annual interest rate. only 1 billion people have access to electricity by 2015. To 100 reach this target, the scenario estimates that 100 percent of IEA/OECD 2010. the urban population and 30 percent of the rural population will have grid access. Of the remaining 70 percent of the rural population, 75 percent will be served by mini-grids and 25 percent will be served by off-grid solutions, such as solar home systems. These estimates are taken as indicative of a potential market share of these technologies. 92 Note that the present value of costs under the two payment options is the same (at a 30 percent interest rate, a rate typically faced by poor people in developing countries). Estimates of the addressable market are not based on the assumption that finance is available for free or at low rates. Rather, the estimates assume that the business model used to sell the product or service embodies a way for the supplier, or a related financing institution, to embed financing in the product offering. Capital costs are recovered with commercial interest, but the up-front payment is removed and replaced with a level stream of monthly payments. 93 While amortizing the remaining 50 percent at an interest rate of 30 percent over the three years. 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We foster sustainable economic growth in developing countries by supporting private sector development, mobilizing private capital, and providing advisory and risk mitigation services to businesses and governments. This report was commissioned by IFC through its Sustainable Business Advisory, which works with companies to adopt environmental, social, and governance practices and technologies that create a competitive edge. IFC seeks the broad adoption of these practices to transform markets and improve people’s lives. The conclusions and judgments contained in this report should not be attributed to, and do not necessarily represent the views of, IFC or its Board of Directors or the World Bank or its Executive Directors, or the countries they represent. IFC and the World Bank do not guarantee the accuracy of the data in this publication and accept no responsibility for any consequences of their use. 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