By Inez Murray

The majority of the world's people are barely subsisting on meager proceeds from their micro businesses. Whether they begin their day by separating a carton of soap into smaller portions to sell on the street for two rupees apiece, or by sewing school uniforms, few manage to break the cycle of poverty. They are looking for an immediate return from their work – enough money to eat, enough money for their families to survive.

This issue of Changemakers Journal spotlights how social entrepreneurs can find ways for these entrepreneurs to not only survive but to prosper by creating economic value. While the wearying work of small producers and traders may feed a family, it does not add value to the economy in which they live. Creating economic value, and creating it NOW – with the same urgency that these families need to survive – is the focus of this month's articles (right).

The majority of small entrepreneurs are crowded in the low-barrier-to-entry and low-value-added businesses such as food processing, street vending, tailoring and machine repair. Most of them live at, or below, the poverty line.

"Low-value-added" businesses are easily entered into ("low-barrier-to-entry") and require little outside input (buildings, machinery, utilities, labor). They therefore have little effect on their host economies.

While selling second-hand clothes may have an effect on one family's finances, the efforts of a clothing cooperative, as the Coopa-Roca sewing cooperative demonstrates, can change the living standard of an entire community. Economic value is only created by turning raw materials into new products: the more sophisticated the transformation process, the more value is created.

Nevertheless, the informal economy, where most of these microentepreneurs are located, is making a huge contribution to world economic output and employment, and its importance is growing. It accounts for an estimated 45 to 55 percent of non-agricultural GDP in most developing economies. In the 1990s alone, the informal sector accounted for more than 83 and 93 percent of all new jobs created in Latin America and Africa respectively. ¹

Small Farmer as Price Taker

However, small producers face a variety of barriers to increasing their income. For example, for farmers these include lack of access to raw materials such as seeds, or to fertilizer and pest controls that allow higher yields.

A farmer might also have little access to affordable, appropriate technology such as water pumps that increase productivity; access to transport that enable them to sell in regional and national markets at higher prices; access to credit; and access to more land. Critically important, the small farmer has little capacity or means to add value to his or her products.

Most of the value is captured down the value chain – in the various stages of conversion from raw materials to finished goods – during the transformation and marketing processes. This is true for most traditional agricultural sub-sectors, such as dairy or cocoa, where manufacturers and distributors tend to capture most of the value and therefore make most of the money.

Similarly, because small farmers, by definition, produce only small quantities, they lack the advantages associated with scale – a term economists use to describe the fact that as more units are produced, the cost per unit decreases. Thus, small farmers cannot compete on price with larger businesses. This makes them price takers – especially when they produce cash crops where price is determined largely on the commodity exchanges that are located far from their shores in the world's financial markets.

Small Clothing Manufacturers Face Impasses

Small clothing manufacturers face a series of impasses, particularly when they want to scale-up production or increase value. They pay top dollar for raw materials because they cannot buy in bulk.

Their sewing machines may be of variable quality, with no two machines producing the same stitch, making it tricky to have consistent finishing. Lack of formal training often makes costing and pricing difficult. As a result, they may spend too much time on a product line that doesn't even breakeven.

Likewise, without formal training it is difficult to size patterns – traditionally a very skilled and highly paid job in the formal sector. When small clothing manufacturers get large orders, manufacturers may find themselves going up against unscrupulous buyers who fail to pay for months on end.

Last but not least, globalization has forced many manufacturers out of certain, formerly profitable, segments such as jeans that are now mass-produced elsewhere at much lower cost – a trend that is likely to continue.

Birth of Microlending

For years, development professionals, NGOs, scientists, governments and the private sector have been working to identify solutions to these problems, some of which have improved the livelihoods of millions of small producers. For example, 20 years ago the poor were considered a bad credit risk because they lacked traditional forms of collateral, such as property, and ready-made financial statements that showed healthy balance sheets.

The innovation social entrepreneur Muhammad Yunus, an economics professor in Bangladesh, has provided a solution to this problem. Yunus founded the Grameen Bank, which gathers microentrepreneurs into small groups to co-guarantee each other's loans. If one defaults, the others make-up the difference.

Social pressure, along with the promise of higher loan amounts, allow microlending organizations like Grameen to achieve higher repayment rates than the average commercial bank. Such successful business models have been built around this concept that group lending institutions now reach thousands – and in some cases millions – of small entrepreneurs.

Other innovations are emerging. Assessing business and household cash flows together as a single, integrated unit, and taking non-traditional forms of collateral, makes it possible to lend to micro- and small entrepreneurs as individuals. Now the microfinance sector is experimenting with providing other financial products and services such as housing loans, savings facilities, insurance and pensions.

Microfinance has provided important lessons for the social entrepreneur. First, it demonstrates that the poor are not just creditworthy, but that they are a profitable market segment, and this has attracted the interest of the private sector.

Second, it offers a service that customers see provides immediate benefits – a critical factor for people whose day-to-day survival is a challenge. Third, it has created business models of enormous scale: Grameen, the largest microcredit organization, reaches more than 4.5 million borrowers.

Fourth, the business models are relatively easy to duplicate. There are now more than 10,000 microfinance institutions throughout the world.

Finally, the microfinance sector has created an infrastructure on which other services can be grafted or channeled. For example, microinsurance products can be provided through joint ventures between microfinance institutions and insurance companies.

Mapping the Value Chain

But microfinance still has many frontiers to cross. Not least is the fact that the client base tends to be dominated by small traders, as opposed to small producers. Cost factors make it more efficient to operate in densely populated (urban and semi-urban) areas where traders dominate.

The standard loan is short term and consists of a small amount of money that must be repaid on a weekly basis with no grace period. This works well for traders because their capital rotates on a daily basis, but it is not so good for producers who have a production cycle and need time to realize a return from their investment – particularly if they've invested their loan in a piece of capital equipment.

And credit is no panacea. Even if loans were better tailored producers' needs, credit would be a necessary but insufficient means to increase small producers' income.

To find opportunities to increase small producer's income, it is necessary to think more holistically about their competitive position. Social entrepreneurs start by mapping the value chain for a given product, or a specific class of small producers.

By analyzing the value chain, social entrepreneurs identify where and how value can be added. They learn about the needs of a particular class of small producers; the resources available to them; the economics of the industry in which they operate; new market opportunities; potential allies and competitors; and the producer's culture and traditions. After completing this analysis, they can create customized and integrated solutions that tackle all stages of the value chain.

Powerful Visions Create New Value

Two of the most successful integrated solutions are India's first large milk cooperative, founded by Dr. Verghese Kurien, known as India's "father of the white revolution," and the Turkish Development Foundation, which was founded by Anton Unver and focuses on the poultry subsector. These organizations have benefited millions of small producers.

Kurien developed a business model that manages to tackle most, if not all, of small dairy producers' constraints. India's dairy producers have faced constraints that are typical for small producers in rural areas, such as inability to access efficient feed supplements, animal husbandry practices at a micro scale (two or three cows per family), and a consistent buyer at a fair price.

Supported by professional management, Kurien's model enables producers to set their own business policies, adopt modern production and marketing techniques, and enjoy services that they could not otherwise afford nor manage as individuals.

Kurien's milk cooperative, Operation Flood, has been so successful that it has been widely replicated. It now reaches 96,000 villages and is owned by 10.7 million farmers. Its distribution system provides an infrastructure for producing other foodstuffs and rural products, and it even supports health workers and educators who work at the local level.

A New Industry from Scratch

Turkey was importing most of its chicken meat when Anton Unver started working in the poultry sector. Now Turkey is a net exporter. Its poultry industry generates more than $200 million in annual revenue and employs tens of thousands of people.

Unver developed a vertically integrated system to support poultry producers and processors that literally created an entire new industry from scratch. Tens of thousands of small producers benefit by managing small-scale poultry farms and investing in feed mills, chicken meat-processing facilities, egg distribution systems and marketing companies.

Kurien and Unver had powerful visions and were able to mobilize an entire subsector to create new value for their small producer clients. Although it took decades to realize their visions, they managed to gradually increase their scale of operations by introducing incentives for all participants at each stage of their projects' development. They live and breathe the principle of "creating value and creating it NOW!"

This issue of Changemakers Journal presents three cases, each of which highlights an innovation for small producers. These innovations combine two fundamental concepts that help small producers overcome their most critical competitive constraints.

The first involves getting small producers to join forces in cooperatives or associations – not only to market their products, but also to create new value by accessing the capacity to process/transform raw materials. The second innovation involves adopting a niche marketing strategy and capturing additional value by creating a product that is sufficiently differentiated that consumers will pay a premium for it.

Tapping Consumer Demand for High Value Goods

Hector Marcelli recognized that certain changes in consumer tastes and preferences would provide opportunities for small farmers and rural producers. For example, rising health and environmental consciousness boosts consumers' demand for organic food, sustainable agricultural practices, eco-tourism, and products created according to the principles of Fair Trade. ²

Consumers will pay a premium when products are certified as meeting certain standards. This stimulates the growth of small producer organizations that make everything from organic cosmetics to chocolate.

Hector connects these organizations with a support system that includes venture capital from socially responsible investors, technical support, "certification" mechanisms, and of course, markets. He follows a niche marketing strategy, and is developing a business model that has serious potential to be scaled-up.

The model developed by social entrepreneur Maria Leal similarly focuses on targeting a niche market: haute couture. Maria set up a co-operative of small producers in a poor neighborhood of Rio de Janeiro.

High-end fashion allows for margins that compensate for lack of scale. Great design adds significant value, as does quality fabric and skilled craftsmanship.

Like all social entrepreneurs, Leal creatively leverages resources around her: much of her fabric consists of the "ends" – pieces left over from fashion houses after they've produced a line.

Leal gets free design input from well-known designers, plus free manufacturing advice from local entrepreneurs. She knows that establishing a name is key in haute couture, and she has aggressively promoted her product in fashion magazines, fashion shows and on TV.

Leal also invests in her staff. Hers is no sweatshop. It is chic to wear her product, not just because of great design, but because it is made using the principles of Ethical Trade ³ which gives the consumer a guarantee that a product is produced under good working conditions for a fair wage.

Finally, Meera Bhattari, a Nepali, knows that her country has two resources that work hand-in-glove. The magnificent Himalaya mountains – which attract many tourists – and a long tradition of craftsmanship. She set up a cooperative of craft producers in the city of Katmandu.

Like the craft industry in many countries, the critical barrier to growth is access to markets, particularly the higher-end tourist and export markets. This usually requires a range of interventions along the value chain.

Finding buyers – preferably individuals who want to buy significant quantities on a regular basis – is first and foremost. Design input is usually necessary because it's important to adapt to the tastes of consumers in industrialized countries.

Ensuring consistent quality often requires technical assistance, as does ensuring that orders can be produced on time. Meera works with 150 small producers in her shop and also outsources to 850 other small producers.

Creativity and Technology are Key Ingredients

All three of these social entrepreneurs have connected the dots to make win-win business models in which both producers and consumers gain. Each has thought holistically about the value chain in which they operate and figured out ways to unblock bottlenecks.

Each has adopted a niche marketing strategy and sought premiums by ensuring high quality and "certification," including adopting the principles of Fair Trade and Equity Trade. Each has been very creative in leveraging resources.

While all three social entrepreneurs have developed very interesting business models, many challenges lie ahead. Figuring out ways to help small producers create economic value requires time and investment.

To achieve any real impact on the global level, these models must be capable of reaching large numbers of small producers and must be sufficiently robust to be replicated in different subsectors and countries. Social entrepreneurs must also ensure that their innovations will live beyond their own charismatic presence.

But the most significant challenge is figuring out new ways to add value given the resource base available to small producers. Here creativity and technology are key.

All stakeholders must be involved. It is important to engage communities of small producers in figuring out solutions for themselves because this very act, in and of itself, can have significant spin-off effects.

The private sector must be encouraged to get involved. For this to happen, social entrepreneurs' business models must be capable of generating a return on investment.

Finally, governments and civil society must work together to create an enabling environment that puts small producers at the center of national and international industrial policies, and in the consciousness of consumers. We must all work to identify solutions with the same degree of urgency that a soap vendor seeks to earn rupees from street sales.