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| Designing and Implementing (Woodfuel Supply)
| Climate Change
In the world of business, ‘financing’ is a necessary link between products and services, as both the supply side and demand side need the required capital to either invest in business infrastructure or buy goods. Financing is needed for monetary cash flows, support activities that enhance the quality and reduce the cost of products and services, increasing customer awareness, and building market share.
For the product supply, availability and the cost of financing determines whether it is feasible to start up a business and the price demanded for the offered products and services. Strategies to address supply side financing include direct subsidies as start up grants, soft loans, and measures to reduce production costs. Production costs include material costs, and the design and efficient production process and technology.
On the demand side, the willingness and capacity to pay will strongly influence the effective demand for the product. Strategies to address demand side financing include direct subsidies as buy down grants, awareness-raising and product promotion campaigns, and micro-credits schemes.
Access to financing is a key factor in enabling target groups to purchase modern cooking energy in development countries.
| ‘I like your stove – but I cannot afford to buy it. It is too expensive for me!’|
Many have come across this statement in the process of developing a programme for the promotion of improved cookstoves. Often there is a perfect stove that fits the needs of the target group perfectly, and yet they say they cannot afford it.
If you meet this statement, you have several options:
- Analyse the statement: Perhaps ‘I cannot afford to buy your stove’ is just the socially accepted way of saying ‘I do not like your stove’ (maybe because it is not perceived as a good stove or maybe the access to firewood is not a ‘burning issue’ to the person in the household who is controlling the cash).
- If the statement is really true, you might consider simplifying your stove design to compromise between performance and cost. Even the best stove – if used by only a few households – will not contribute to development as much as a stove with medium efficiency used by many thousands of households.
- Often this is the point at which the issue of financing comes on the agenda. Providing financial assistance to the producers or the users of the stoves may assist in removing barriers for access of the target groups to improved cook stoves.
There is a comprehensive debate on subsidies for stove producers, as well as stove users, usually focusing on aspects such as their impact on sustainability or the feasibility of direct targeting.
Any development programme is designed to spend money for the promotion of a change process. By definition, this money is a subsidy to the development initiative, as the beneficiaries do not pay for the services rendered to them by the programme. The subject of lively debate is therefore not the subsidy of development processes as such, but the ‘IF’ and the ‘HOW’ of direct or indirect subsidies to the producers or users of improved cookstoves.
Financial assistance for stove producers and commercial stove users (such as restaurants) adopts a similar manner to that used by micro-finance institutions. The beneficiary of the loan is earning money with stoves (production or use) and can use the profits to repay the loan.
Loans for households for purchasing improved cookstoves in households are ideally generating the repayment rates through fuel savings. A precondition therefore is a fully commercialised fuel market. It is difficult to prove that ‘time saved’ through reduced wood collection, less washing and cleaning, and faster cooking, translates directly into more cash income.
This chapter outlines two different finanincing mechanisms for cookstove dissemination: subsidies and micro-credits. Firstly, the topic of subsidies is outlined in a systematic manner, with a listing of commonly perceived opportunities and challenges in the use of direct subsidies for consumer goods and other end products.
Secondly, many aspects of using microfinance especially microcredit for improved cookstove promotion (in collaboration with microfinance institutions (MFI)) are discussed in more detail.
Purchasing Improved Cookstoves Through Subsidies
If, as outlined above, a development programme is a sort of indirect subsidy to a specific change process, it is not following the same rationale as a commercial banking decision. A loan from a development agency is commonly perceived as a grant rather than something to be repaid. The financing of a cookstove programme will benefit from collaboration with a micro-finance institution, because this will visibly and organisationally distinguish between aid and business.
As with many other products, the array of subsidies for stove dissemination is extensive, and their use is hotly debated among those working on cooking energy. A good example of this is the debate reported on the HEDON Household Energy Network.
There is general agreement that a purely market-driven approach on the dissemination of improved cookstoves in rural areas without established markets would be a challenge. The high risk, and consequently high financing costs, of introducing products into remote markets would lead to prohibitive stove prices. Since existing fuel markets in these locations consist mainly of woodfuel (collected at no monetary cost), and kerosene or LPG (which typically is subsidised already), there is little economic motivation for households to buy an improved cookstove. So the debate is not about whether to use, or not use, subsidies at all, but rather how they should be used.
There are two approaches to subsidies for stove dissemination:
- The use of direct subsidies to bring down the selling price of stoves (partially or totally).
- The use of indirect subsidies to help establish a market through activities such as subsidised training, product promotion, awareness creation.
The essential question for both these approaches is how to make subsidies that are both fiscally sustainable and that lead to a rapid increase in market uptake (with subsequent improvements in costs, performance, and supply chain reliability).
What Distinguishes Direct from Indirect Subsidies?
Direct subsidies typically involve a direct cash transfer to the stove producer or consumer.
Various types of direct subsidies are described as follows:
- Buy down grant to reduce the product price directly. There are different approaches to channel a buy down grant, such as paying the producer for every system sold or installed, or providing the money (or an equivalent voucher) directly to the customer. The extreme form of a buy down grant would be a 100% subsidy of the consumer price (an approach often used by the health sector).
- Start up grant and/or soft loan to support the setting up of production and marketing infrastructure for a stove producer. To start up new (or to extend existing) businesses to rural areas often includes a high primary investment in infrastructure, staff and marketing, with high risks and transaction costs. Start up grants or long-term loans with low interest rates spread out the initial financial burden for stove producers.
- Custom reduction for imported stoves (and components), and tax reductions for stove producers or fuels. A few improved stoves require imported high technology components, though this is less common than for other renewable energy technologies (e.g. solar home systems). Their added value will mostly take place in their country of origin, so there is little scope for custom exemption. During the start up period, there is a case for a reduction in income tax and value-added tax for stove producers. Tax reductions on many fossil fuels, such as LPG or kerosene, have a much greater influence and a negative impacht on cookstove dissemination.
For the following reasons direct subsidies are promoted:
Economic theory demonstrates that several requirements have to be fulfilled for markets to function effectively (Perman 2003:124). In practice, these conditions may not exist where stoves are being disseminated.
Using this argument, subsidies are justified where there is:
- Asymmetric information: Lack of demand, as indoor air pollution and its consequences are endemic and thus people are not aware of risks
- Insufficient market power: Market failure both on demand and supply side, as the existing effective demand might be insufficient to overcome the opportunity costs for a market driven supply chain.
- External effect on the public good: Indoor air pollution makes respiratory diseases more likely and advancing deforestation and desertification reduce the available firewood resources. Because these external effects increase health and environmental expenditures, the state takes responsibility and interest to protect the public goods of health and environment.
Direct subsidies can significantly increase the use of a cooking technology or fuel, particularly by the poorest strata of the rural population. For example, in Brazil, subsidised LPG reaches 98% of households, including 93% of rural households, at a cost of slightly less than US$60 per year per low-income household. It has been stated that there is a benefit to many of those living in poverty, even if direct subsidies are abused, and that these benefits at least match the costs lost by abuse.
Direct subsidies are more transparent than indirect subsidies.
Direct subsidies are criticized for the following reasons:
Inhibiting market development
When direct subsidies (particularly 100% subsidies) are applied, beneficiaries expect that the product will continue to be given away in future. This undermines a sense of ownership by the customer, and devalues the economic value of the item on both supply and demand sides. This undermines commercial activities and inhibits a sustainable market.
Cooking technologies and fuels are not basic health-related goods in the same way as drugs or mosquito nets. The adoption of an improved stove depends on its quality, and on its image as a modern, useful and efficient improvement, rather than the user’s capacity to pay for it. A free widely-distributed product could well be perceived as inappropriate and be sold on for profit, or not used at all.
Targeting and abuse of subsidies
In some cases, direct subsidies are abused, for example, when stoves are bought for a subsidised price, but instead of using them, they are sold in other regions for a higher price.
The additional transaction costs of direct subsidies are substantial and often underestimated. The costs are difficult to foresee and to assess, e.g. for: development of policy and target of the subsidy, voucher systems development, identifying beneficiaries and deciding if they qualify for subsidy (when their status may be changing by the day), and monitoring the effects of subsidy. The costs may not justify the expected benefit.
The distribution of partially or fully subsidised items to low income households is often used by political parties to rally for the election of their party. Targeting sometimes becomes distorted by political influences, as observed in Malawi with food aid and boreholes.
There is no clear answer as to whether subsidies, and in particular direct subsidies, should be used or avoided. The question must be answered individually for each case, assessing the specific circumstances and framework conditions.
Indirect subsidies refer to subsidies that reduce the price to the consumer, but not through a direct cash transfer.
The most frequent types of indirect subsidies for improved stoves are:
- Public awareness and product promotion campaigns increase public understanding, and thus increase the demand for improved stoves (see following chapters on Creation of Public Awareness for Improved Cookstoves). This awareness could be about indoor air pollution alleviation and the subsequent reduction in respiratory diseases, or the cost reduction potential of efficient cooking technologies. If the cost of such promotions is not borne by the stove promoter, this is an indirect subsidy.
- Introduction of standards and certification systems that increase the product image and give the customer a certain guarantee about quality. During set-up and introduction of such a system, external support is important. In the longer term, an established market can finance certification and quality systems without external support.
- Support from microfinance institutions (MFI) can bridge the gap between the stove price and what people can afford by providing micro-credit to stove customers. In some cases, MFIs might not cover the total target area, or might not have sufficient resources for large numbers of new customers, they could be supported with start up grants to extend their infrastructure, or by refinancing with soft loans, to extend their portfolio. A more detailed discussion of the use of micro credits can be found in the section below.
- Training and capacity building is one of the most frequently used types of indirect subsidy. It can include business, technical and administrative training – in most cases given free of charge, and providing support to stove producers, financing institutions, NGOs, local government and certifiers.
- When support to research and development for improved stove technologies uses public finance, this indirect subsidy is not recouped in the final product price.
The term smart subsidy will be introduced to describe an appropriate subsidy, which dealt with the problems that have been described above. The term is not precisely defined, as it needs to be adopted to every specific case.
The central questions when designing a smart subsidy deal with the 'why', 'when', ‘how’, ‘how much’, ‘to whom’, ‘under what rules’, ‘at what cost’, and ‘what is the exit strategy’? Answering these questions leads to different strategies for particular circumstances. However, some important recommendations can be highlighted for smart subsidies:
- Support only those rural energy products and services that would not be viable without the subsidy, but for which there is verified sufficient demand.
- Follow rules that are clear, transparent and predictable to all parties and do not create or reinforce a monopoly or other market distortion.
- Focus on a clearly defined target group.
- Link subsidies to optimal results. Support least-cost options that are neutral in terms of technology choice, but which are high quality and energy efficient, and encourage commercial participation
- Focus on increasing access by subsidizing the initial purchase price rather than the operating costs or fuel consumption
- Rely on existing and sustainable financial resources (budget, cross subsidies, foreign help, carbon finance) and have a clear exit strategy.
- Cover all aspects of the project including end-use investments, to encourage pro-poor income-generating end uses.
Purchasing Improved Cookstoves Through Mircrofinance
Introduction to Microfinance
This section defines the key expressions used in microfinance, and the main concepts needed to understand how it works. Later, it describes the principal mechanisms for accessing micro-credit for improved energy access, and how to develop a project with a microfinance institution. The chapter ends by discussing the potential of microfinancing, and the limits to its use in disseminating improved cooking technologies.
This term describes the provision of sustainable high quality financial services to poor or low-income clients for productive purposes or for buying goods or services. It includes micro-credit, savings, insurance, and fund transfers.
Microfinance Institution (MFI)
This can be an NGO or a regulated bank that offers microfinance services like micro-credit, insurance or savings. The main roles of the MFI are to:assess whether the clients are credit worthy, disburse the loans, collect the installments, and follow up those who default on their repayments. A number of methodologies have been developed in the microfinance industry to support the MFIs so that they become economical sustainable entities.
This is a microfinance instrument that facilitates very small loans to poor or low-income clients whom the banks do not consider viable as customers. In general these individuals lack collateral and therefore cannot meet even the most minimal qualifications to gain access to traditional credit. For this reason, micro-credit is often disbursed via a group guarantee, as a group loan, where group members guarantee for each other. More wealthy clients that can offer a small collateral can also qualify for an individual loan.
The majority of MFI clients are women. In most cultural contexts, men do not accept the group lending principle, so they have to qualify for an individual loan. Experience has shown that they are less reliable in repaying the debt.
The year 2005 was declared the United Nations Year of Microfinance. In 2006, Muhammed Yunus and the Grameen Bank got the Nobel Peace Prize in 2006. Since that time, microfinance has become a well known, successful tool to reach those living in poverty in regions with weak infrastructure and low incomes.
Can microfinance play a role in expanding access to improved cookingstoves (ICS)?
Microfinance splits high investment costs into affordable monthly rates, offered through Microfinance Institutions (MFI). MFIs develop a whole network of close relationships with their customers.
- Credits have to be disbursed
- Installments have to be collected
- Failures have to be followed up and, in this case, guarantees have to be recovered
| Note: ‘Microcredit’ needs an institution in the background. It is not a tool by itself.
Only a few projects that combine energy and microcredit have been implemented successfully. The main reason is the lack of communication between the different stakeholders in the finance and energy sectors. The following sections seek to create a mutual understanding between these sectors. They are specifically targeted at practitioners who are implementing ICS programs. These sections will support them to understand more clearly the perspective of those working in microfinance.
Integrating a Microfinance Specialist into an Energy Project
One mechanism is for the energy project to hire a microfinance specialist, and together they will develop an adapted mechanism specifically for the project. In this case, it is important to integrate the microfinance specialist into the preliminary market research, because the criteria to identify potential clients or ICS producers will not only include ability and willingness to pay, but also their eligibility for credit (measured by their known levels of repayment or default). Failure to integrate the specialist at an early enough stage is a common problem, as the project manager may search for a financial mechanism, only to discover too late (when the client assessment is undertaken), that only a few of those identified as end users in the market survey are creditworthy for an energy loan. Exactly the same can happen with a potential ICS producer. They may fulfil important criteria in terms of skills and technical know-how, but not the requirements of an MFI to get a loan.
A microfinance system for improved household energy access requires a solid infrastructure in the background, as offered by MFIs. In small, time-constrained energy projects, it is often difficult to organize such a system and to reach long-term sustainability. The following section discusses the use of microfinance as an end user financing tool.
High Value Turnover versus Business Costs for Profitable Microfinance Systems
The main barrier in financing the customer for energy products is the price and financial requirements of an energy-financing mechanism.
The development of a sustainable microfinance infrastructure is costly and time-consuming because of the following:
- Cost of field and market research, business planning, monitoring and evaluation
- Staff salaries; staff must be hired and trained
- ICS stock has to be bought and managed
- Transport has to be organized
- Logistics, maintenance and overhead costs
- Access to cash flow as technology needs to be paid up-front
- Interest payments from capital borrowed for up-front costs
All these issues represent business costs, and are part of the service charge that the customer has to pay in addition to the price of the energy system itself. It needs a large number of clients to keep the running costs down and to reach break even, so most microfinance energy projects start with a high value technology to ensure that the turnover has a high value, and business costs do not exceed 30% of the total price charged for the item. The problem of financing a lower price technology in the initial phase, such as an affordable improved stove, is that the business costs do not depend on the system cost. The implementation of financing a ten Euro stove is not much cheaper than a 500 Euro solar system, since the dissemination infrastructure and networks that need to be developed, are the same.
It is recommended that low-cost energy technologies, such as improved cookstoves, work with microfinance institutions that are already in existence. In this case, additional costs are only generated for organizing the supply and, in part, for any technical services that may be required (if they are part of the business plan).
Developing an Improved Cookstove Project with an Microfinance Institution (MFI)
This section provides an overview of project development requirements, and steps that need to be taken when developing a partnership with a micro-financing institution.
Requirements for Cooperation
MFIs need a high level of technological standardization to be effective and economically sustainable. This is the reason why a few successful microfinance ICS programs are disseminating LPG. The technology they are using comprises standardized bottles and a high quality management system. MFIs have a long credit relationship with their customers, focusing on their businesses (and not their households). The mutual trust, which is an important part of the relationship, makes MFIs a powerful partner for awareness creation and marketing. On the other hand, the MFIs demand reliable products and producers. Where this relationship breaks down, it will adversely affect the stove image and its dissemination. Since the client networks of MFIs are highly organized, this kind of bad news could spread rapidly. It is thus recommended that improved stoves are not disseminated through MFIs until the stove is well tested and quality control instruments are implemented.
The stoves should first prove to be reliable as follows:
- Quality standards, within a measurable range, must be met by producers. Any rumor that a product is likely to fail, or not save as much as promised, will be disseminated rapidly within an MFI network, and could lead to the failure of the whole project.
- Serious reductions in the performance of the stoves during the period of repayment will be seriously damaging. Stove efficiency will almost inevitably decrease while in use. Loans should be adopted based on a realistic fuel saving scenario. The more often that good news is disseminated within the MFI network that ‘the product almost pays itself’, the greater the number of consumers.
Finding the Right Microfinance Institution (MFI) Partner
Depending on the type of stove that is to be disseminated, the appropriate MFI should be approached as described:
- MFIs that target the poorest – mainly people earning less than a dollar per day
- MFIs that target the active poor – generally people who have already a small business and need capital to grow
- MFIs that focus on urban and peri-urban areas
- MFIs that focus on rural areas
- MFIs with NGO status
- MFIs with banking status
These categories are not exclusive. For an energy project, it is important to identify the focus of each MFI, identify the right one, and decide how it can be approached for a given product. More details regarding the categories can be found in the background document.
MFI Client in Ghana, cooking in her restaurant
Almost all MFIs have available data regarding the categories of businesses they finance. A first evaluation of those categories will give an insight into the relevance of cooking-fuel dependent businesses (for example: Restaurants, canteens, food processing and bakeries).
Some MFIs such as FINCA (www.villagebanking.org) already monitor the cooking fuel expenses of their clients. Depending on the project relevance and assessment, MFIs will decide whether or not to go for an ICS project.
The assessment should include an investigation of which MFI clients might become part of the ICS supply chain through production and retailing services and the like. If the MFI data is not precise enough, these aspects should be included in the market assessment.
Assessing an Microfinance Institution (MFI)
The goal of this type of institutional assessment is to identify the capacity of the MFI to develop, implement and evaluate an ICS project, and to determine the required institutional support required in terms of capital, facilities and training.
The following aspects should be taken into consideration:
- How is the decision-making process organized?
- What is the hierarchical structure?
- Will the board only approve a new project after market assessment and business planning has been completed?
- Available funding and capacity to access capital:
- Can the funding and accessible capital be used?
- Is it flexible enough for the ICS project – especially if the MFIs have a banking status?
- Human resources capacities
- Is there enough staff for the implementation of a new project?
- What are the professional capacities of the staff? Can their skills meet the requirements of an ICS project?
- Does the MFI have training capacity?
- What is the capacity of the MFI regarding the integration of staff with new professional backgrounds?
- Finally, does the MFI have experience implementing projects?
- especially projects that concern a field other than finance
Integrating Microfinance Institution (MFI): Field and Market Surveys
The goal of the field and market survey is the determination of the product requirements and the marketing strategy.
The methodology to be chosen for a field- and market survey depends on following factors:
- The available socio-economic and cooking habits data at baseline. This may have been collected during earlier project phases.
- The usual approach to market surveys for that particular MFI. The MFI should be integrated as much as possible with the project in this phase.
It is advisable to start the market research with a qualitative approach as: it helps to inform the research questions needed by the MFI in a later quantitative study; and it can introduce and train MFI staff about improved cookstoves. In some cases, the monitoring and evaluation tools of the MFI are already so mature and highly developed that just a few questions need to be added.
It is important to differentiate between cooking habits for the home and cooking within and away from the home for a business.
Data that should be assessed for both categories of cooking include:
- Cooking fuel supply habits (purchasing/collecting) of all social groups represented within the MFI clients.
- Microeconomics of the cooking fuel(s), including the monetary cost and time spent on collection.
The business case needs an analysis of the competitive situation: In some business cases, it may not help to save money on fuel with an ICS if the technology slows down the entrepreneur to a rate below that of his/her competitors.
It is necessary to determine the different roles within the supply and cooking process:
- Is the respondent the typical MFI client or what is his/her relation to this client?
- Who pays for a cooking appliance?
- Who does the cooking?
- Who collects the wood?
- Who pays for cooking fuel?
Case study: Cooking in Uganda
Experience has shown that many MFI clients in Uganda delegate cooking and collecting fuel to maids or daughters. The willingness to spend money for a stove in such cases is rather low, and the time for collecting fuelwood does not have any relevance. However, in restaurants many MFI clients cook for themselves and buy their own fuel. Thus, the economics of time/ fuel saving is highly relevant.
If the assessment is compiled with the usual monitoring and evaluation tools of the MFI, a lot of inter-sectoral correlations are possible. These will be very helpful for the development of the marketing and awareness-raising programme.
The analysis of the results of an institutional assessment, and the field research and market research forms the initial phase of product development.
The outcomes play a major role in determining which business model is the most appropriate:
- What role should the MFI play within the supply chain?
- How should the financial product be designed to be appropriate for ICS clients (accessibility, duration, interest rates, etc)?
- Will the MFI have any say in the dissemination programme (logistics, stock level)?
- Should they be involved in awareness raising and marketing?
- Should they have inputs into quality control and management?
- How will the processes (communication, financial, product) between retailers, producers, MFI and loan clients be designed?
Depending on the results of this process, the project plan has to be developed to consider marketing tools, location of initial commercial enterprise, strategies for scaling up, methodologies for monitoring and evaluation.
The Potential Benefits and Possible Limitations of using Microfinance
Cooperation between ICS programmes and MFIs has great potential mainly because it is engaged with a shared target group, women, who otherwise have little access to capital.
Potential Benefits for Cooperation Between MFI and ICS programmes
- Market aspects
- Overcoming the financial barrier for investments in energy efficiency
- Bringing together demand, and offering access to new markets
- Advantages in competition for the MFI in case the MFI market is oversupplied
- Social aspects
- MFIs are necessarily interested in enhancing income generation.
- MFIs focus on empowering women by enabling female entrepreneurship.
- Quality aspects
- The long-term relationship with the customer that makes it possible to offer additional services may be needed for a sustainable implementation of ICS.
- The MFI can become a central stakeholder in consumer protection as quality is a key aspect in the relationship with their client.
- Monitoring and evaluation
- The performance of the MFIs clearly indicates the quality of their services.
- MFIs have to monitor and evaluate their projects regularly through third parties to get access to finance.
- The monitoring methodologies of MFIs offer an opportunity to evaluate the impact of energy on social aspects.
- MFIs have an expanding market, reaching actually more than 133 Million borrowers worldwide. (www.microcreditsummit.org)
The Limits of MFIs for Energy Outreach Programmes
- Only a few MFIs are aware of the ‘energy’ market without it being promoted.
- MFIs are bureaucratic and hierarchic organizations, they need time to move.
- To promote energy in a sustainable way, MFIs need to develop expertise within their companies; this expertise should be technology-neutral so that they are able to compare different products.
- A lot of training and communication at different levels of management are required.
- Only a few MFIs will target the very poor.
- If they target the very poor, they generally do not offer special credit terms.
- They generally work exclusively in urban centres, especially in Africa and Latin America.
- MFIs work in a very standardized way.
- MFIs show a high staff fluctuation, especially at operational level.
- Profitability depends on the number of clients per credit officer and the repayment rates.
- MFIs will finance only eligible clients and each MFI has its own criteria to identify them. For a larger investment, a long-term relationship (credit history) with the customer must exist or an adapted collateral is needed.
- The target group that does not pay cash for energy (for example if biomass is collected and not purchased), is normally not eligible for an energy loan.
- MFIs always group together their clients, and with a very decentralised supply, such as improved cookstoves, it becomes more and more expensive to do this as logistically they are harder to reach.
The Risks Taken by MFIs Working in Energy
An energy project approaching an MFI for cooperation should be aware of the risks from the MFI’s perspective:
- Developing an ICS programme means that they are taking on new infrastructure-related product development services, including parts of a supply chain
- To go into an ICS program requires new investment, and a move into unknown business field.
- A new loan product has to be designed and implemented with a high likelihood to be less profitable than common loan products
- A lot of new knowledge has to be brought into the company
- Partnerships need to be developed and stabilized
- A quality management system has to be introduced
- Stocks and logistics have to be developed.
All these risks need to be addressed by the energy project as early as possible to encourage the involvement of the MFI.
This article was originally published by GIZ HERA. It is basically based on experiences, lessons learned and information gathered by GIZ cook stove projects. You can find more information about the authors and experts of the original “Cooking Energy Compendium” in the Imprint.
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