Selling solar products through the informal sector is not just financially attractive in places like Ethiopia—it’s also the key to reaching the largest number of customers.
“Ninety thousand solar lanterns sold last quarter,” said Mr. Li. He was sharing sales numbers for his solar appliance business in Ethiopia, and I couldn’t believe it.
To put that number in perspective, the Global Off-Grid Lighting Association pegs the average number of all solar lighting products sold in Ethiopia in a single quarter at around 250,000 units. Close to 80 percent of Ethiopians live in rural areas with little to no access to electricity. Assuming two lanterns for every household with an average five people in each, Mr. Li might have provided energy access to close to a quarter million people within months.
As far-fetched as that sounds, it is actually quite possible. The catch, however, is that Mr. Li’s sales are illegal. He sells his products on the informal market, outside of the government net, avoiding taxes and the country’s formal quality regime. As a result, his sales, though meaningful, are at risk of coming to a halt.
A rapidly growing market for solar lanterns and home kits is driving an energy revolution in Ethiopia. Like many low-income countries in Asia, Africa and Latin America, Ethiopia is a point of focus for international development and finance institutions as well as donors. Such organizations are channelizing tens of millions of dollars into Ethiopia for energy access. In order to maximize the impact of their investments, they need to have an understanding of local requirements in order to provide tailored financial flows.
To that end, I visited Ethiopia earlier this year as part of a study for the United Nations Sustainable Energy for All (SE4All) program. In collaboration with partners, we at TFE Consulting helped SE4All understand the quantity and type of financing needed for energy access in five developing countries across Africa and Asia. Ethiopia was a focus country, along with Nigeria, Kenya, Bangladesh and Myanmar.
What I learned in Ethiopia was encouraging. On the face of it, the market has a high focus on quality: the World Bank’s “Lighting Africa” quality certification is mandatory for products, and most key suppliers have this. Additionally, distribution networks are well established and run deep. Financing support is also available through micro-finance institutions offering consumer financing and banks that provide corporate credit to suppliers. Overall, the growth rate of energy access businesses is between 10 to 20 percent, and there is tremendous optimism about the size and future of the market
Despite these promising facts, sales volumes across the formal sector are actually quite low. One reason is that foreign exchange is scarce, which makes imports difficult. Also, debt comes with crippling conditions like interest rates of 12 to 15 percent and high collateral requirements. As a result of these barriers, most businesses operating in the formal sector sell between 2,000-5,000 lanterns a year. The volume of solar kits is a third of that. Even the largest formal supplier we met sold fewer than 20,000 lanterns a year. These numbers are an order of magnitude lower than those in the informal sector, where some suppliers, like Mr. Li, sell more than 100,000 lanterns a year.
Mr. Li is a true entrepreneur. He runs a cottage-industry-style assembly line for solar lanterns on the outskirts of Addis Ababa. To avoid customs that confiscate products lacking certification, he imports individual components and assembles them locally. Once assembled, he sells wholesale to agents. His price is 20 percent below any formal market product. He is greatly optimistic about his business and plans to convert his makeshift assembly line into a proper factory by the end of the year.
Mr. Li is not alone. From our interviews and data, we estimate that as much as 65 percent of Ethiopia’s solar lantern market transacts in the informal sector. In the vast, highly congested bazaar at the edge of Addis known as Merkato, thousands of vendors sell a wide range of consumer products at cutthroat prices entirely outside the tax and regulatory net. Deals here are large, conducted on trust, not paper, and executed quickly. This is where business gets done.
The Merkato, and other markets like it, are the beating heart of the energy access market in Ethiopia. They are deeply connected to informal networks that have low transaction costs, high flexibility, wide geographic reach and access to the most remote areas of the country. These features make such networks the backbone of many developing markets like Ethiopia and the channel of choice for energy access suppliers looking for large transaction volumes, low costs and speed-to-market.
A focus on volume is understandable in a market that offers razor-thin margins. Customers have very low purchasing power and are therefore highly price sensitive. A slight increase in prices can put products out of reach for a large segment of customers. Selling through the informal sector then is not only financially attractive for enterprises due to scale and lower transaction costs, but also a key lever in reaching the largest number of consumers.
The Merkato is notorious. It is a black market, and the authorities continuously try to crack down on it. Formal businesses complain about unfair price competition due to avoided taxes. Many buyers with access to formal markets often avoid it for fear of being cheated. Moreover, access to financing of the kind our project was trying to solve altogether overlooks this market segment.
If international financiers, government, donors and consultants like us are serious about improving energy access for the poor, there is a tradeoff to address. We have to recognize the advantages of the informal sector and develop an approach that incorporates and leverages its many strengths. For a start, we need to recognize the scale and reach of informal markets and find ways to include them when planning financing for energy access. By failing to do so, we are failing to turn lights on.
Mohit is an expert on energy in emerging markets. At TFE Consulting, he leads projects to help international companies navigate the energy transformation underway globally.
The views in this article are his own and do not reflect the views or findings of any studies or organizations mentioned.