February 4th, 2018 by The Beam and GreenTechMedia
“Ninety thousand solar lanterns sold last quarter,” said Mr. Li. He was sharing sales numbers for his solar appliance business in Ethiopia and I couldn’t believe it.
To put this in perspective, the Global Off-Grid Lighting Association pegs the average number of all solar lighting products sold in Ethiopia in one quarter at around 250,000 units. In addition, close to 80% of Ethiopians live in rural areas with little to no access to electricity. Assuming two lanterns for every household and on average five people in each, Mr. Li might have provided energy access to close to a quarter million people within months. The catch, however, is that Mr. Li sells his products on the informal market, outside the government net, avoiding taxes and the country’s formal quality regime. As a result, his sales, though impactful, are at risk of being terminated.
A growing market for solar products in Ethiopia
A fast growing market for solar products is driving an energy revolution in Ethiopia. Like many low-income countries, Ethiopia is a point of focus for international development and finance agencies as well as donors. Such organizations are channeling tens of millions of dollars to Ethiopia for energy access. They are keen to understand local requirements in order to tailor financial flows and maximize the impact of their funds.
To that end, I recently visited Ethiopia and met and discussed the market’s dynamics with local enterprises, institutions and the government. What I learned was encouraging. On the face of it, the market has a high focus on quality: the World Bank’s “Lighting Africa” quality certification is mandatory for products and most key suppliers have this. Additionally, distribution networks are well established and run deep. Financing support too is available through micro-finance institutions offering consumer financing and banks that provide corporate credit to suppliers. Overall, the growth rate of energy access businesses is between 10–20% and there is tremendous optimism about the size and future of the market.
Despite such facts, sales volumes of solar products across the formal sector are quite low. One reason is scarce foreign exchange which makes imports difficult. Also, debt comes with crippling conditions like interest rates of 12–15% and high collateral requirements. As a result of these barriers, most businesses operating in the formal sector sell between 2,000–5,000 lanterns a year. Even some of the largest formal suppliers sell fewer than 20,000 lanterns a year. These numbers are an order of magnitude lower than those in the informal sector, where some suppliers, like Mr. Li, can sell over 100,000 lanterns a year.
Mr. Li is a real entrepreneur. He runs a cottage-industry-style assembly line for solar lanterns on the outskirts of Addis Ababa. To avoid customs that confiscate products lacking certification, he imports individual components and assembles them locally. Once assembled, he sells wholesale to agents. His price is 20% below any formal market product. He is greatly optimistic about his business and plans to convert his makeshift assembly line into a proper factory by the end of the year.
Mr. Li is not alone. From interviews on the ground, an estimated 65% of Ethiopia’s solar products market transacts in the informal sector. In the vast, highly congested bazaar at the edge of Addis known as Mercado, thousands of vendors sell a wide range of products at cutthroat prices entirely outside the tax net. Deals here are large, conducted on trust, not paper, and executed quickly. This is where business gets done.
The Mercado, and other markets like it, are the beating heart of the energy access market in Ethiopia. They are deeply connected to informal networks that have low transaction costs, high flexibility, wide geographic reach, and deep access to the most remote areas of the country. These features make such networks the backbone of many developing markets like Ethiopia and the channel of choice for energy access suppliers looking for large transaction volumes, low costs and speed-to-market.
A focus on volume is understandable in a market that offers razor thin margins. Customers have very low purchasing power and are therefore highly price sensitive. A slight increase in prices can put products out of reach for a large segment of customers. Selling through the informal sector then is not only financially attractive for enterprises due to scale and lower transaction costs but also a key lever in reaching the largest number of consumers.
The Mercado is notorious, of course. It is a black market. The authorities try to crack down on it. Formal businesses complain about unfair price competition due to avoided taxes. Many buyers with access to formal markets often avoid it for fear of being cheated. Moreover, international development financing efforts altogether overlooks this market segment.
If we are serious about improving energy access for the poor, there is a trade-off to address. We have to recognize the advantages of the informal sector and develop an approach that incorporates and leverages its many strengths. For a start, we need to recognize the scale and reach of informal markets and find ways to include them when planning for energy access. By failing to do so, we are failing to turn lights on in the homes of many of the poor that rely on such markets. The next time I visit Ethiopia, I will start my journey of inquiry at the Mercado rather than finishing there.
By Mohit Anand. A version of this article was first published on Greentech Media.