Get Rid of the Grid?
An emerging business model that aims to reduce energy poverty holds real promise. But it needs a jump-start.
Consider this all-too-plausible scenario: You are visiting a small rural village somewhere in sub-Saharan Africa. The sun has just disappeared behind the horizon. To your left, kids run from a dusty, makeshift soccer field toward the simple houses—most of them built of nothing but wood and soil—where they live. It is pleasant now, and you enjoy a light breeze. But just 15 minutes later, it is dark. Night has fallen, and all you hear are muffled voices and some indistinct animal sounds. You wait for the lights to go on, wait for the village to re-appear from the night, but nothing happens. In the darkness, you feel uneasy. Then, suddenly, your iPhone 5 rings.
In 2005, just 5 percent of sub-Saharan Africans had a mobile telephone. In 2014, less than 10 years later, mobile network operators (MNOs) boast more than 250 million unique subscribers (30 percent of the total population), employ more than 3 million people, and generate revenues of more than $20 billion per year. Over the same period, meanwhile, the number of household electricity connections in the region has barely kept up with population growth. Indeed, only about 30 percent of the population has a connection to the electrical grid.
Over the past six years, according to a 2013 report, companies in the mobile phone sector in sub-Saharan Africa have attracted roughly $44 billion in commercial capital. Over the same period, companies that provide energy services to households in the region have attracted less than $100 million in capital, and less than 25 percent of that amount has come from commercial investors. That disparity is all the more surprising given the size of this potential market. There are 125 million energy-poor households (corresponding to more than 550 million people) in sub-Saharan Africa, and last year they spent an estimated $20 billion on meeting their basic energy needs (through the purchase of kerosene and batteries).
Together with other people in the international development and impact investment communities, we have worked for many years to identify ways to provide basic energy services to the millions of off-grid households that still exist in emerging markets. One rural electrification initiative after another has raised people’s hopes, and one after another, they have either failed to grow or failed, period. National electric grid expansion has not kept up with population growth; retail sales of solar equipment (such as portable lanterns and roof-mounted home systems) have increased dramatically but still have a market penetration of less than 5 percent; and even the best mini-grid projects have not managed to scale up in a meaningful way. It often seems as if there are more conferences and reports about access to energy than there are electrified villages in all of sub-Saharan Africa.
At some point in 2012, we realized that this situation is poised to change. There is a real chance to expand energy access as fast as MNOs were able to expand mobile phone access. The vehicle for doing so, we believe, is a model called the distributed energy service company, or DESCO.
Put simply, we see in the DESCO model the potential to provide rural households and small businesses with a better service than they currently have, for less money than they currently pay, and to do so while generating attractive wages for employees, opportunities for entrepreneurs, and financial returns for investors. It’s possible to provide households with enough energy for basic appliances—LED lights, mobile phones, television and radio sets, and even small productive equipment, such as a sewing machine or a refrigerator—for a fee that is lower than their current expense for kerosene and for the batteries that they use for flashlights. And any business that can offer a better service for less, while making a profit as well, is a business with potential.
Flipping a Switch
DESCOs don’t sell products for cash as a distributor of energy access products would. Rather, they install electricity-generating assets—such as a rooftop solar system or a connection to a microgrid—at dwellings and small businesses and then collect payments from customers. Those payments might occur on an ongoing basis (as in a lease model) or until a customer has effectively purchased an asset (as in a rent-to-own model). In any event, a DESCO operates much like a utility company.
Unlike a typical utility, however, a DESCO focuses not on selling as much electricity as possible, but on providing customers with the services that they want—electric light; a way to charge their mobile phone; the ability to use a radio, a TV, or a personal computer—at a price that they are willing to pay. The logic of the DESCO model works along the following lines: Customers currently spend $10 per month to light their homes with a couple of kerosene lamps. A DESCO might offer those users unlimited light from four LED light bulbs, plus an outlet to charge their mobile phone, for $7 per month. It’s a great deal for customers, and it’s good business for the DESCO.
This is a big market to capture: In sub-Saharan Africa, households collectively spend more than $10 billion every year on lighting alone. What’s more, DESCOs don’t need to create demand for a new offering; they need only shift the spending that energy-poor customers already lavish on inferior services. So why haven’t people adopted the DESCO model on a large scale before now?
It often seems as if there are more conferences and reports about access to energy than there are electrified villages in all of sub-Saharan Africa.
The big change that has transformed the situation over the past five years is the proliferation of mobile phone services. Consider how a DESCO operates: The company installs numerous small, inexpensive village grids, or numerous solar home systems in rural areas, and customers pay for services in small amounts over time. For this business to be profitable, the DESCO needs to minimize its costs for maintenance, customer service, and payment collection. Leveraging mobile services—mobile data to manage the assets and create an incentive to pay, and mobile payment technology to monetize the assets cost-effectively—will enable DESCOs to keep their costs at a sustainable level.
Moving Out of the Dark
Demand for electricity certainly exists, and the DESCO model has great potential. Leading companies such as M-Kopa Solar (Kenya), Off.Grid:Electric (Tanzania), and Mera Gao Power (India) have started to accelerate their customer acquisition rates. Prominent early-stage venture capital firms (Khosla Ventures, Vulcan Capital) and strategic investors (Solar City, Schneider Electric) have begun to enter this emerging sector. But there are important obstacles that block expansion of the DESCO model.
The DESCO sector is in its infancy. In sub-Saharan Africa, there about a dozen companies that pursue the DESCO model. The largest of them (M-Kopa) has about 75,000 customers; the entire sector serves fewer than 250,000 households. (Remember:The region is home to more than 125 million households without access to energy services.) And, to our knowledge, none of the companies that are pursuing a DESCO model has yet reached a true break-even point—let alone profitability. To reach a meaningful scale, the DESCO sector needs to attract support from several important entities.
In the near term, the sector needs entrepreneurs who recognize the potential of the DESCO model and who are ready to adapt it to markets such as sub-Saharan Africa. The sector also needs risk-tolerant capital—capital that ranges from grant funding to commercial venture financing. Equally important, the sector needs skilled investors who can manage that capital and work with entrepreneurs as they grow their businesses. In the medium term (one to two years from now), the sector will need institutional investors who are willing to fund the capital-intensive DESCO model in the same way—with debt capital—that they supported the microfinance sector after it graduated from a nonprofit activity into a robust commercial endeavor.
Before investors will deploy serious capital, however, governments need to revamp their approach to regulating energy services for people without access to a national grid. Regulators need to shift away from setting universal rate structures that apply to all energy providers. Those rate structures protect customers from utilities that operate as a monopoly. But in a market where competition exists—and the DESCO sector is such a market—regulators should enable customers to make their own choice.
In particular, regulators need to recognize that pricing for DESCO services functions in a way that is fundamentally different from how pricing works in a traditional, grid-based utility system. Recall the example that we used earlier: A DESCO charges $7 per month for the use of four LED lights, together with mobile phone charging. Because of recent gains in energy efficiency, the DESCO uses only about one kilowatt-hour per month to deliver that service. So if regulators mandate a rate of (say) 30 cents per kilowatt-hour, they reduce the revenue of the DESCO by more than 90 percent. In effect, they make it impossible for DESCOs to operate. As a result, customers will have no option but to continue paying $10 per month for kerosene light.
Ten years ago, building a business around mobile phone services in sub-Saharan Africa seemed like a crazy idea. By comparison, the idea of building a business around the DESCO model seems obvious—so much so that, in our view, it’s only a matter of time before people in every African household will use a DESCO service to charge their mobile phone at home.