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

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.

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.