Get Rid of the Grid?

November 2, 2014 Editor 0

By Pepukaye Bardouille & Dirk Muench

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?

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.

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Categories: Social Innovation

Tags: Energy poverty, sub-saharan africa