15 minute read 23 Aug 2019
Girls collecting water lake desert village

Eight ways entrepreneurs and investors can bring safer drinking water to millions

By

EY Global

Multidisciplinary professional services organization

Contributors
15 minute read 23 Aug 2019

Discover how your investment in a safe water enterprise can trigger a ripple effect of inclusive growth.

World Water Week (25 – 30 August) is the annual focal point for the globe's water issues, organized by the Stockholm International Water Institute (SIWI). Experts, practitioners, decision-makers, business innovators and young professionals from a range of sectors and countries travel to Stockholm to network, exchange ideas, foster new thinking and develop solutions to the most pressing water-related challenges of today.

To mark World Water Week 2019, we’ve revisited the award-nominated study How can a trickle become a torrent? (pdf)  conducted by EY and Unilever, which was launched at the event last year. The insights highlighted provide practical guidance for impact entrepreneurs and investors.

Imagine a life without safe drinking water. It isn’t easy. Most of us take it for granted that we can just turn on a tap and fill a glass. But that’s not an option for roughly one in four of the world’s population — the 2.1 billion people who still lack access to safe drinking water.

With half of all hospital beds in low-income countries occupied by people with water-borne diseases, it’s hard to overstate the importance of reaching the United Nations Sustainable Development Goal (SDG) of equitable access to safe, affordable drinking water for all by 2030.

While the current rate of change isn’t fast enough to hit that target, we still see grounds for optimism. We see it, in particular, in the growing number of impact entrepreneurs who are innovating new models for the scalable and sustainable provision of safe water in underserved communities.

United in our desire to accelerate their progress, it’s why Unilever engaged EY to help identify the most promising Safe Water Enterprises (SWEs) around the world, and to develop a deeper understanding of their business model dynamics and barriers to growth.

  • EY is proud to collaborate with Unilever to extend the value of our knowledge, skills and experience, on a not-for-profit basis, to help identify and support high-potential safe water enterprises. This is part of our long-standing commitment to scaling the work of impact entrepreneurs, and uniting forces with Unilever and our wider client base to collaboratively work toward realizing the UN Sustainable Development Goals. The reason is simple. When impact entrepreneurship works better, the world works better. Whether by expanding affordable access to vital goods and services, accelerating creation of quality jobs, or advancing the economic participation of women, young people and underrepresented groups, scaling impact entrepreneurship creates ripples that can change millions of lives.

The market-leading SWEs whose businesses form the basis of this report are already serving more than 15 million people across Africa and India. What’s more, it’s our belief that, with the right focus and support, they can reach hundreds of millions more.

Our research and analysis suggests this rests on three things above all:

  1. Recognizing the high fixed costs inherent in any SWE operating model, which means that only SWEs that operate at scale can achieve true sustainability
  2. Recognizing that there is no “ultimate” SWE model that works best in all circumstances and that the path to scale therefore depends on finding the best fit to a particular blend of market conditions
  3. Recognizing the need for investors to take a balanced view of SWEs’ potential to generate returns — from a social impact as well as financial perspective — in order not to overlook promising and scalable models for safe water provision

We’re extremely grateful to the extraordinary SWE management teams with whom we have worked to compile the insights in this report, and to the impact investors who back them.

Access to safe water

500 million

people lack any access to safe water.

Access to safe water

300 million

people have to travel more than an hour to fetch safe water.

By shining a light on these issues and offering practical guidance on what to do about them, we hope to make it easier for their life-changing businesses — and others like them — to find a path to even greater impact.

1. Don’t over-engineer your business

Succeeding in making safe water accessible and affordable to all by 2030 means accepting that the “ideal” answer to water treatment may not always be the best one. Counterintuitive though it may seem, sometimes “good enough” is better.

Reverse osmosis (RO) is the preferred treatment technology for raising the quality of water to World Health Organization (WHO) guidelines, as it handles both biological (i.e., pathogens) and physical contaminants (e.g., arsenic, fluoride). But it’s not always necessary.

The potential customer base for any SWE is limited by the price it charges for its water. This takes prices charged — ranging from 10 cents per 20 liters of water to around a dollar — and maps them to the amount that customers of a given daily income can afford to spend, over the long term, to meet their daily water needs (based on WHO estimates).

Daily incomes set limits on the revenue that can be generated at a given site, which in turn determines levels of operating margin and economic viability. This fact alone rules out sustainably deploying RO in certain parts of the world. While the economics may work in urban or peri-urban locations, where sufficiently affluent customers can be found in sufficiently high densities, it’s likely to be a very different story in rural and very low-income communities. The upfront investment in RO equipment, or the costs of leasing it — while also paying for other overheads such as salaries, site rentals and energy — may simply be too high for SWEs to recoup.

The health consequences of poor water, sanitation, and hygiene services are enormous. I can think of no other environmental determinant that causes such profound, debilitating, and dehumanizing misery.
Margaret Chan
WHO Director General 2007–2017

Especially in these areas, it’s important not to overlook cheaper purification techniques that, while not achieving the “gold standard” of RO, are nonetheless fit for purpose and provide opportunities to treat much more of the water being consumed by huge numbers of people at the very base of the global income pyramid.

For example, electrochlorination enables water to be decontaminated using little more than table salt and an electric current. Perfectly suitable where the source of contamination is bacterial rather than physical (i.e., from fecal matter), it can make potable the drinking water of hundreds of millions of people at significantly lower cost. But even this radically cheaper approach to purification has its limits. While achieving substantially lower costs than it could have done with RO, one SWE we worked with in India believes this model is still only financially viable for around one in six of the villages it wants to reach. Beyond that point, population sizes and densities simply don’t allow sufficient sales volumes to cover fixed costs and break even.

2. Focus on differentiators

The primary activities of an SWE value chain typically involve water extraction, treatment, distribution, retail and quality monitoring. A typical SWE is a modular assembly of options, such as the types of water sources, or treatment and distribution technologies deployed, at each part of this value chain.

Getting these basics right is important, but there are another set of critical enablers that our research suggests are even more valuable. These are where SWEs can really differentiate themselves from one another:

Adaptive management

A culture of continuous improvement and adaptive management was found in all successful organizations we observed. SWEs need to be willing to tweak the existing models (see Insight 3), trim unnecessary overheads and seek out partners (whether government, corporate, foundations or individual investors) to bring innovative new ideas and business model configurations into play.

Life cycle financing

By this we mean how an SWE configures its financial model so as to generate sufficient returns to sustain existing assets (e.g., carrying out capital maintenance and accounting for eventual asset replacement) and grow the business.

Approaches to financing growth vary widely between SWE models. For example, some opt to apply heavily for grants to provide early-stage funding until they reach sufficient size and can become self-sustaining. This approach tends to be more common in, and more suited to, India, where an abundance of private investors and mandatory corporate responsibility requirements enshrined in the Companies Act mean there is plenty of capital in search of social impact projects.

Other models — more common in Africa — are configured for higher operating margins, based on the need both to recoup upfront investments (e.g., capital expenditure and loans to franchises), which they must often fund themselves, and to attract venture capital to get to scale. In such cases, franchising can be an important tool for accessing additional capital from a wide group of entrepreneurs, who each have skin in the game. We found this approach generally more successful in India, where entrepreneurs are more able to access capital than in other low- and middle-income countries.

Talent and incentives

Finding the right entrepreneurs to run sites or manage franchisees requires rigorous recruitment processes and investment in skills development. SWEs that excel in these areas also create incentive structures that align each other’s interests, allowing entrepreneurs to generate more money for high performance.

SWEs based in Africa tend to build in training programs for their entrepreneurs, not unlike a business finishing school. Conversely, Indian SWEs tend to benefit from a wider pool of entrepreneurial talent, typically working with existing entrepreneurs, as well as being able to tap into a burgeoning skills base of software developers capable of building in-house the tools needed to manage the business at scale.

Technology

Developing or investing in technology can seem challenging for an organization operating with finely tuned economics, but it’s an important tool for reducing cost and improving the customer experience. For example, one of the SWEs we worked with has been able to deploy automated water dispensers with wireless reporting in a “hub-and-spoke” formation around its purification sites. Water levels at the automated dispensers are tracked remotely and a refilling truck is sent before the tank runs dry. This has allowed the SWE not only to increase its reach from one water site by a factor of 15, but also deliver a totally reliable water source for its customers.

3. Focus on key financial drivers

As a nascent sector, many of the most promising SWEs around today have spent years incrementally tweaking elements of their model, testing new strategies and ironing out creases. The difference between a successful and unsuccessful SWE often rests in these seemingly minor variances, informed by maintaining a firm grip on key financial drivers. Above all, these include:

Revenue

A combination of the achievable price that can be charged for the water and the volume of sales, the main driver of revenue is a site’s proximity to a sufficient number of customers. Site selection — either placement nearby to high density populations or using home delivery to clusters of smaller settlements in a hub-and-spoke configuration — is therefore a decisive factor influencing sales and sustainability.

Fixed operating costs

Varying widely from country to country, these include staff costs, energy not used in water production, rent, maintenance and repairs, and vehicles. They are influenced by the availability of talent, local wages, as well as the modes of retailing that a kiosk operator employs. Use of automated dispensing technologies can bring down the cost of employing staff. Some SWEs have been able to drastically reduce their operating costs by agreeing concessions for land usage with local governments (similar to a public private partnership arrangement), generally passing these savings on to customers in the price charged for water.

Marginal costs of water treatment and distribution

Tending to be higher in Africa than in India, these typically include consumables (such as bottles, caps and chlorine), energy used in water production, distribution costs (driver salaries and vehicle fuel) and royalty payments. The principal driver is the method of water distribution, e.g., by motorized or manual vehicle, or through gravity-fed overhead piping.

We believe this latter approach could transform the economics of water distribution in densely populated areas by creating sales volumes high enough to rapidly shrink marginal costs.

Site development costs

These include structures, fittings, treatment systems, borehole development and solar installation. The biggest cost element is that of materials, which is again driven by the location of the SWE. We saw evidence of costs for building a site in the Americas at 87% higher than in sub-Saharan Africa, and 250% higher than in India. The choice and configuration of treatment system is also an important factor here.

Site development costs

250%

higher cost for building a site in America than in India.

4. Sweat your assets

An SWE is an asset-intensive enterprise with a low-priced product. Like the budget airline that needs to minimize the time its planes are on the ground to turn a profit, making sure those assets are highly utilized is critical to operating successfully.

Construction costs, treatment equipment, leases for land, operator salaries, and energy and maintenance costs can all mean it’s costly to get a site up and running. However, actually producing treated water involves very little additional cost. The gross profit on each liter of water sold can be more than 80%, which represents a high contribution margin.

This means two things. On the downside, it means that an SWE needs to consistently sell strong volumes of water to break even. On the upside, once that breakeven point is reached, sales of each additional liter of water produced begin accruing directly as profit on the bottom line. This matters when you consider that, on average, none of the SWEs we analyzed was operating equipment at more than 50% of capacity.

Simply put, a highly utilized water site can outperform an average one exponentially. It’s why SWEs should take great care both in tuning their business models and in site selection, taking into account population density, willingness and ability to pay for water and site accessibility.

5. Manage those sites like a portfolio

Just like any other portfolio, overall returns are dictated by the individual performance of the investments it comprises. For this reason, we believe SWEs should be prepared to divest sites that cannot achieve a minimum standard of performance. This is not to suggest the pursuit of profit should outweigh their social mission; it is simply to recognize the dependency of portfolio economics on the economics of individual sites.

At every SWE we studied, there were wide variations in performance between sites and it wasn’t uncommon for SWEs to carry loss-making sites, as well as highly profitable ones. This can be justified on grounds of meeting a social need, but it should be grounded in a conscious and deliberate strategy of cross-subsidization, not accidentally allowing underperforming sites to drag down the performance of the overall portfolio.

Optimizing across the portfolio and minimizing the number of unprofitable sites can help impact investors see where their efforts can be best placed.

6. Stay lean on capital

Working capital requirements can act as a significant brake on growth for SWEs, which is why it pays to be ruthless in pursuit of capital efficiencies.

We found significant differences in the capital intensity of different SWE business models, at least partially attributable to businesses’ willingness to innovate and experiment with different combinations of choices along the SWE value chain.

For example, some SWEs have been quicker to install technologies that drive down working capital requirements, such as pre-payment cards. These not only reduce the number of problems associated with cash handling, but crucially also reduce the whole organization’s net trade cycle (i.e, the difference in days from when suppliers must be paid to when customers pay, or franchisees remit funds). This means less of the enterprise’s funds are locked up in unproductive assets, freeing them up for use in revenue generating assets or making new investments, such as opening a new kiosk.

7. Think impact returns, not just financial returns

Traditional methods of measuring capital efficiency center on returns on invested capital (ROIC), which provides financiers with a way of comparing economic returns across potential investments. For an impact investor, this is a necessary but insufficient lens through which to judge capital efficiency, because it does not take into account the purposeful trade-offs SWEs make in the clean water sector. SWEs are often intentionally run as close to breakeven as possible, generally to facilitate lower prices for customers.

In light of this, we developed an alternative view — impact return on capital (IROC) — which looks at the number of people capable of subsisting each day from the water production achieved by each SWE. To arrive at this measure, we took SWEs’ water revenues and prices charged to calculate the amount of water sold. We then worked out how many customers could live off that amount of water using WHO daily water consumption requirements. IROC therefore represents the number of daily water consumers per thousand dollars of invested capital.

Viewed through this lens, we saw massive variation in the performance of different SWE models — from as low as 12 to as high as 70 daily beneficiaries per thousand dollars of invested capital among RO operators, and often exceeding 200 in the case of chlorination models, which benefit from much lower capital requirements.

Combined with the more traditional ROIC lens, an interesting picture emerges. While some SWEs are clearly geared towards stronger economic returns, others are configured for higher social impact. The point is not for SWEs and impact investors to build or evaluate an investment case on the basis of one measure or the other, be it ROIC or IROC. Rather it’s to recognize the value and importance of taking a balanced view and looking at value creation from multiple perspectives.

8. Build a balanced scorecard to blend perspectives

Taking into account all the insights we have presented, we recommend that SWEs adopt a balanced scorecard. This blends traditional investor metrics with impact metrics and sufficient financial data to provide clarity on historical and forecast performance at both site and portfolio levels. It could also be supplemented with additional metrics — for example, in relation to operational efficiency or customer and employee satisfaction — according to SWE board wishes. Bringing all these measures together in one place would provide a solid management dashboard, focused on the critical metrics that really drive performance, and which empower SWEs to strike an appropriate balance between financial and impact returns on capital.

Conclusions

While substantial progress has been made in recent years, the stark reality is that roughly a quarter of the world’s population still lacks easy access to safe drinking water. If we are to change that picture and reach the SDG target of equitable access to safe, affordable drinking water for all by 2030, then identifying and supporting scalable SWEs is undoubtedly a vital part of the equation.

The inherent challenge in this is that there is no “cookie cutter” approach to building SWEs that are individually capable of becoming self-sustaining, and collectively capable of reaching hundreds of millions of people, rather than the millions we see today. There is no ultimate SWE model that works best in all circumstances; there are only models that are better suited to different market conditions.

This requires that SWEs pay close attention to the particular blend of circumstances in which they are operating and tailor their business models accordingly, in particular being careful not to over-engineer solutions to the extent that they limit economic viability and capacity to scale. Further, a clear focus on differentiators and key financial drivers, and a portfolio management approach to optimizing performance at both individual site and enterprise levels, can offer investors a more credible growth story.

Transforming the reach and impact of SWEs also requires that investors adopt a more balanced view of returns to encompass not only financial returns on invested capital, but also impact returns. Estimating the number of daily water consumers reached per thousand dollars of invested capital, a new “impact return on invested capital” (IROC) measure offers the means for a more holistic approach to building and evaluating investment cases that can help guard against promising and scalable models for safe water provision being overlooked.

Summary

With the right focus, impact entrepreneurs and investors can play an even bigger role in bringing safe, affordable drinking water to millions.

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By

EY Global

Multidisciplinary professional services organization

Contributors