Smart subsidies - creating markets instead of distorting them

In prevalent subsidy regimes governments generally give direct or indirect (monetary) benefits to a company to overcome the initial barriers of serving certain markets that are not viable but provide health improving or public goods. This market intervention allows supplying specific products at a set market retail price (INVESTOPIA, 2017). In a similar way are ODA (official development aid) agencies and governments supporting or have been supporting specific products or services for the poor. Examples are highly subsidised or even free distribution of health products, malaria nets or setting up of water fountains and wells. This practice is unfortunate for sustainable market creation as if these subsidies are not retained, either the products are not available anymore (because the production is not profitable anymore) or it will lead to higher market prices for consumers and thus most likely much lower sales as people are not willing (and able) to pay a significantly higher price for the same safe water product (e.g. filters or safe water). This is specifically the case when catering to the Base of the (economic) Pyramid (BoP). Smart subsidies on the other hand are not market-distorting instruments rather they stimulate market creation processes and support the establishment of safe water enterprises as such in a sustainable and long-term manner. The concept of smart subsidies advocates for potential monetary interventions to intervene at the operational level of an enterprise. Rather than subsidising the production process as such by covering operational costs [OpEx] (as it is often the case with conventional subsidies) smart subsidies support capital expenditures [CapEx] not directly linked to production and the supply chain. Additionally can smart subsidies intervene in the blueprint and validation phase of a business, facilitating feasibility studies, business model evaluation, product development or payment schemes etc. (for more information please see factsheets of the blueprint phase and validation phase). An important consideration whether subsidies are smart or not is the criteria of long-term availability and what happens if the subsidies are withdrawn. If the supply chain collapses, subsidies were not smart. In this sense, one-time subsidies are smart while continued subsidies may distort markets and lead to collapsing supply chains and business models if withdrawn (FERRER DUCH & KELLER, 2010; GOLDSTEIN, 2016; FEDERAL RESERVE BANK OF BOSTON, 2012). The table below provides an overview and concrete examples distinguishing smart and un-smart subsidies:

Over the past decades, people at the bottom of the economic pyramid (BoP) have always be seen as beneficiaries only, without any purchasing power and neither as consumers (for more information see also BoP factsheet). This perception led development institutions, governments, NGOs and philanthropists to provide products or services for the poor either free of cost or highly subsidised (It must be clarified that the delivery of free goods during emergency situations is clearly an exception, such as the need to contain outbreaks of diseases and provide relief in distress situations, and has accordingly been separated from the discussion at hand). If chlorine tablets are given free of cost, there is no need to buy them, no incentive to sell them, and consequently, they will not be available when needed. The results (of distorting subsidies) are destroyed or inexistent markets, no emerging customer base, wrong product perception and unsustainable supply chains, especially in the safe water sector (GRASER, 2015). Hence it is not surprising that the term “subsidy” often has a negative connotation (MURDOCH, 2006) as it is associated with hampering the real development of markets, leading to unsustainable outcomes and benefitting only a minority of the population. This is the reason why smart subsidies should foster the support of sustainable

Smart subsidies are interesting for safe water entrepreneurs, NGOs, investors and governments willing to create sustainable markets for HWTS and water services that benefit the poor, but have thus so far not been able to reach scale and significant impact. This factsheet can be used to reach out to public and private donors to make them understand how subsidies can sustainably be integrated in a market creation process by allocating money in a comprehensive and sustainable manner. Additionally, it can be used by safe water businesses to understand how subsidies could support their business development in a sustainable way especially with a focus on what happens if subsidies stop.

To apply smart subsidies within a safe water initiative one has to reflect on how financial support could develop safe water markets and ensure long-term profitability of a business.

The key criterion whether a subsidy is smart is sustainability. Ask yourself: How will your business be impacted when a subsidy is withdrawn or reduced? If the amount of money is reduced, are you still able to distribute and sell your product or service under the same conditions (price and profit)?

To identify smart ways of subsidising your business, identify what costs and investments can be externally covered that are not affected by the daily production:

• Costs that can be externally covered, that are not interfering the viability of your supply chain and production process.
• Investments in social marketing methods that create or enhance markets and customer base such as providing safe drinking water in schools and all methods to enhance awareness creation.
• One-time investments in CapEx can be smart, while those subsidies that are interfering with the operation and maintenance costs are critical.

Specific smart safe water subsidies include market development methods like marketing, social marketing, awareness raising and capacity building. Practical methods can be increasing visibility of products and services, emphasizing health impacts and medical cost savings when drinking safe water and convenience of using household water treatment solutions (HWTS) (for more information please see factsheet on social marketing). Addressing these public tasks of awareness raising about safe water needs to be aligned with government interventions and can enable public-private partnerships (Box PPP Canvas). If governments are though not able or willing to bear the costs of such campaigns smart subsidies are a financing option to consider. Such approaches can include output-based (result-based) investments to strengthen impact through a variety of means (for more information see factsheet on blended finance). One example are result-based subsidies (e.g. carbon finance) which should be used to expand markets and not to subsidise the daily operations. Even if the revenues of carbon credits decline, e.g. due to lower prices in the carbon market – this should not affect the daily operations if the money is used for the CapEx investments.

Concretely can smart subsidies be implemented with the use of the following instruments:

• Identify ways to develop products or services further to reach larger numbers of customers and thus enhance profitability. Keep in mind: Safe water supply chains are usually a low margin / high volume business.
• Identify potential public-private-partnership opportunities and partners that are willing to subsidise your CapEx or social marketing activities (for more information see also factsheet on blended finance)
• Eliminate un-smart subsidies that are directly linked to production and delivery in your actual business model in the mid-term as it bears a high risk to hamper sustainability.

The case study about smart subsidies in Nepal highlights positive and negative examples of how institutions and NGOs have been dealing with subsidising safe water products and intervening in the safe water market. The example of Tinkisso’s experiences in Guinea reveals that free HWTS distribution has an impact on market development but needs to be executed in a smart way not to undermine private sector development.