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Posted: August 1, 2013
Matt Palmquist

Matt Palmquist is a freelance business journalist based in Oakland, Calif.

 


 
 

A Bottom-of-the-Pyramid Strategy Yields Top-of-the-Pyramid Results

Some analysts have argued that great value waits at the “bottom of the pyramid” (BOP) for firms willing to exclusively target the billions of consumers worldwide who possess relatively little spending power. Others are less optimistic, believing that the low-end market can’t be exploited profitably and sustainably, and that BOP firms, by definition, are too small to alter the competitive balance of the market.

But a new working paper on how incumbents respond to BOP firms finds that their entry into the market can profoundly affect a range of industry dynamics.

In the study, the emergence of a company focusing exclusively on the low-end reduced-price dispersion—or the gap between the highest and lowest prices for the same product—restricted the expansion of the market, creating a higher overall volume of sales and curbing the advantage that high-end firms have to leverage prices and adjust package sizes. In effect, by flooding the market with lower-priced, smaller-sized products, the arrival of a BOP firm forced established companies to adopt some of the same strategies to compete for these customers. The authors also empirically show, for the first time, that the BOP strategy can raise minimum prices and drive down top-end prices, and thus be profitable for low-end firms.

The authors analyzed the Indian pharmaceutical industry, wherein prices for both generic and brand-name drugs fluctuate significantly even in a narrow market that revolves around homogenous, largely equivalent products. BOP firms coexist with high-end multinationals and other large domestic companies in this industry, making it an optimal setting to study the issue. The authors obtained data from a U.S.-based firm that collects proprietary data on the Indian market, analyzing units and sales of the same drug types across 3,500 wholesalers and 55,000 retailers from 1999 to 2011.

Using pharmaceutical dosage strength as a proxy for package size—one of the primary mechanisms through which smaller firms can compete with larger ones—the authors found that the maximum dose of a given drug dropped 12 percent after the BOP firm entered, and the minimum dose rose 9 percent. Additionally, after the BOP firm’s emergence, the maximum price fell 8.6 percent, on average, and the minimum price went up by 15.4 percent.

What’s more, because pharmaceutical companies have to pass publicly announced trials before being allowed to sell their products, the authors were able to track incumbents’ moves in anticipation of facing a new rival. Months before a new low-end competitor’s actual entry into the market, the mere expectation of it led to an increase in the minimum price and decrease in the maximum price. This jibes with previous research that suggested the threat of entry by Southwest Airlines into a particular market lowered established rivals’ prices even before Southwest started operating flights.

And there’s a payoff for firms that target the bottom of the pyramid. The new focal firm tracked by the authors rose 11 spots in four years to become one of the top 10 pharmaceutical companies in India in 2009, despite exclusively focusing on low-end consumers.

“When low-end firms’ choice of package sizes aggregates demand away from high-end firms, BOP firm strategy can achieve a scale of operation that is sustainable,” the authors write. “At a broader level, our results reflect the disruptive role BOP firms play in emerging markets and how incumbents adjust to such industry dynamics.”

 
 
 
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