The Myth of the Poverty Premium

There is a widespread view that people in poverty pay more for their products and services than richer people. This price difference was described by C.K Prahalad and Allen Hammond as the poverty premium, in an article in the Havard Business Review (HBR) in 2002 – which Prahalad expanded on in his book ‘The Fortune at the Bottom of the Pyramid’. However, an article by Ethan Kay and Woody Lewenstein in the April 2013 edition of the HBR cast doubt on the theory, and showed results of an experiment that illustrated that the poverty premium is not always present. The implications for this theory being wrong can have major implications for marketers and by implication market researchers.

The idea behind the poverty premium is that more affluent shoppers can buy more efficiently, for example by driving to discount stores or by buying in larger pack sizes. At one level we can see this is true, the price paid for a can of Coca-Cola in a convenience store in a poor neighbourhood is likely to cost more than the proportionate costs of one can of Coca-Cola purchased as part of a multi-pack from the local equivalent of a WalMart.

Kay and Lewenstein report on an experiment that conducted a study in two parts of Mumbai, India. The first region was one of the world’s largest slums, and the second was the up-market area of Warden Road. Kay and Lewenstein arranged for representatives to buy 40 products from 17 stores in the rich area and 17 in the poor area. They matched the products in terms of effective use, but not in terms of brand or format. The rice purchased in Warden Road might have been in a branded package, and the rice in the slum might have been unbranded and sold loose. The result was that the products, which included electricity, a comb, rice, a haircut, cooking oil, a dress and bananas, cost more in the richer area – i.e. the poorer consumers were not paying a poverty premium, indeed they were paying less than 20% of the figure paid by those in the better off area.

Kay and Lewenstein put forward a Western misunderstanding of the poverty premium as the reason why many new product launches in the developing markets. As an example Kay and Lewenstein describe how Dupont owned Solae launched a soy protein product in the slums of Mumbai – aiming to capitalise on Prahalad’s ‘fortune at the bottom of the pyramid’. The Solar product was launched on the market at 30 cents a packet and failed. Lentils, a staple part of the local diet (i.e. in the slums of Mumbai) can be purchased for less than half the price of the new product.

Kay and Lewenstein illustrate their point with several other cases, all illustrating how Western brands can badly misjudge the bottom of the pyramid. Kay and Lewenstein also explore some of the reasons for the low prices charged in the slum (beyond selling items loose and unbranded). The reasons include the assertion that many of the vendors in the slum are working in the informal economy, not paying taxes or license fees, nor paying the minimum wage, nor incurring the conventional costs of doing business.

The paper from Kay and Lewenstein does not definitively rebut the notion of the poverty premium, but it certainly casts doubt on the way it is sometimes interpreted. The doubt it casts is based on argument, a controlled experiment, and providing credible reason for why so many products and services aimed the bottom of the pyramid fail. The lesson for marketers and market researchers is that in assessing a new product they should not pay too much credence to theory, nor should they assume that the cost bases for competitors is as high as official figures might suggest it is.

The article by Kay and Lewenstein can be accessed here – be sure to read the comments, which include support for the Prahalad view, and an assertion that the authors had misquoted Prahalad’s explanation of the poverty premium. However, the interpretation that Kay and Lewenstein use is certainly a common one, for example it is the bases of Save the Children’s claim in 2007 that poor families pay on average £1000 a year more for essential goods and services in the UK.