June 21, 2017//- I always wondered why a taxi ride in Tanzania is twice as expensive as a similar ride back home in India. The same is true for hotels.
This is counter intuitive as labor in Africa is among the cheapest globally. After working for almost 4 years with African businesses, I have begun to understand why Africa is expensive despite being poor. This article summarizes my findings.
I work at a U.N. agency where I support East African agribusinesses to increase their exports. I meet with various businesses ranging from agro processors to commercial banks. Often I try to understand their pain points while developing their export strategies. One of the most common answers to all questions is “This is how it works in Africa”. I like to call this the Cost of Doing Business in Africa (CoDoBA).
Why are taxis so expensive in Africa?
En route to my hotel from the airport on an unpleasantly hot day, I asked this question to my driver. I was paying him 100 USD/day which is a handsome amount in Tanzania. “I must pay 800 USD every month to the owner for using this car. If it was my own car, I could offer the ride for much cheaper”, said the driver. My calculations started immediately. Assuming a 50% utilization rate, the driver probably gets 1,500 USD/month (100 USD @ 15 days). This leaves the driver with 700 USD. The driver confirmed my calculations. However, he pointed out that he is needed to bribe traffic police and city council officials to keep them at bay.
The remaining money gets lost in fuel and maintenance. Fuel costs are high because traffic is ridiculously chaotic in Dar and roads are in such a bad shape that cars need frequent maintenance. Interestingly most of the decent taxis in Tanzania are imported Corollas. These cars may be cheaper to buy but must be more expensive to maintain. India on the other hand produces its own Innovas and Scorpios which are much cheaper to maintain.
Does the taxi owner make a fortune?
Having ascertained that a Tanzanian taxi driver is no richer than his Indian counterpart, despite the high fares, I started to think if the car owner was making a fortune. 800 USD/ month which sums up to 9,600 USD for a year. The second hand car must cost near 10,000 USD so a near one year payback is not bad by any means! I was starting to believe that this taxi owner must be a rich man and that leasing cars must be a good business in Africa. The only question now was the Cost of Capital.
What do Banks have to say?
Fun fact – Cost of borrowing in Africa is over 20%. Businesses must therefore generate a return greater than this to repay loans. For those who can’t understand how outrageous this is, borrowing rates are under 5% in Europe and close to 10% in India. African banks must then be minting money but this is not how it seems from outside. In fact, a few international banks like Barclays have been closing/reducing operations in Africa.
Before I could ponder much over this, the business realities of the place struck me. Theft is a big problem in Africa that makes operational costs high and unpredictable. I was participating in a negotiation for a Joint Venture between a bank and a collateral management company (Collateral managers allow farmers to access loans against their produce as a collateral by issuing warehouse receipts). This bank was not willing to trust the warehouse receipts as farmers collude with warehouse managers to cheat the banks. The enforcement of laws in the country was so weak that it was almost impossible to punish the wrongdoers. This also explains, at least partially, the high interest rates. Thefts increase cost of doing business and make their performance unpredictable. Moreover, weak law enforcement increases chances of default. So overall, banks interest rates are reflective of the performance of industry in general. The theft problem was so grave that none of the 3 banks I met during that visit were willing to enter into the potentially multi-million dollar revenue generating collateral management industry.
Thinking back on the taxi owner from my example above, I might have overestimated his returns. If he had borrowed the money at such exorbitant rates and was unsure if someone would steal his car tomorrow, 800 USD/month seems a fair price.
Where does the money disappear?
While I pay 100 USD a day for the taxi and businesses pay 20+ % interest rates, most of money becomes the deadweight loss or what I call CoDoBA. The bribe, fuel wasted in traffic, high cost of maintenance, high cost of capital and the risk of fraud are the key components of CoDoBA. All these grow out of weak institutional capacity – whether it is the inability to build transparent laws and decent roads, punish thieves and defaulters or even to incentivize development of a domestic auto industry.
Lessons from Indian businesses operating in Africa
Despite the numerous challenges that Africa offers, Indian business community has managed to flourish. From my visits to many of these companies, I have noted a pattern. Most of the Indian or Indian origin owned businesses get their staff from India (sometimes, even illegally) – preferably from their native village to circumvent CoDoBA, at least to some extent.
The Indian staff are usually put in management positions where they supervise natives. Cultural affinity and lack of opportunities outside ensure that the hired Indians are more honest and diligent. Many of these have also received some management training which is difficult to find among the locals.
Eventually, despite the high cost of bringing them, companies end up saving money by reducing leakages. At times, they also use their Indian connections to raise cheap capital and export produce, further reducing costs. As a result, they become more competitive.
Implications for investors
While it is clear that African institutions need to be strengthened for ensuing long term progress, businesses in the short run can already generate returns for themselves and the society. Following are some recommendations for businesses to re-think the way of doing business in Africa:
Make employees, shareholders: Where law enforceability is a problem, trust building is the way to go. Importing labor is not a sustainable option as labor restrictions are getting tougher by the day in Africa. Businesses must therefore incentivize honest conduct among their local staff.
One way of doing that is to make all employees -from security guard to the CEO- beneficiaries of company profits. The proposal here is not to dole out bonuses but to actually make every stakeholder an owner of the company. Such a scheme will not only bring financial accountability but also social and moral accountability among the staff as well as help in reducing leakages.
This will also incentivize companies to develop native talent thereby ensuring business’ sustainability. Furthermore, companies may provide benefits like gratuity and healthcare to reduce employee turnover and build long-term equity.
Provide patient, fairly priced and strategic capital: Obvious opportunities may not be so obvious in Africa. For example, providing a 75 USD/day taxi or a 150 Euro/day 5 star hotel may seem profitable, but factors like CoDoBA will make it difficult.
Patience is the key as there will be a learning curve. The silver lining here is that the opportunity is big, it is real, and with persistence, one can reach the end of the tunnel. Moreover, investors should leverage their network to provide investees with exposure to markets and management practices that many African companies lack today.
Produce strategically: Businesses must employ a portfolio approach that balances financial and social returns. For example, an obvious way to avoid thefts is to produce things which have limited or no local utility. Various bio fuels, essential oils, etc. would fall in this category.
However, a part of the portfolio must also be dedicated to producing for the domestic market. For example, staples like maize are a big portion of Africa’s import portfolio. Investments in maize production therefore can generate financial and social returns. By balancing the portfolio in this manner, investors will be able to develop a healthy relationship with locals which will encourage long-term loyalty.
Conclusion
Adaptation, more than innovation, is what investors in Africa need. Africa presents a unique business landscape and investors must pay special attention to understanding the local context, including CoDoBA. Like natural resources, the continent has abundance of opportunities. Investors must utilize, and not exploit, those opportunities with win-win solutions. Working with Africans is the only way to develop sustainable businesses in Africa.
By Aman Goel, Agribusiness Team Lead at International Trade Centre (UN/WTO)
