If There is No Rural Finance Do Not Do Feefor Service

From a policymaker's point of view, fee-for-service can sound ideal. A customer can access a solar system for a fraction of the price they would otherwise pay. Instead of paying on a cash basis, or taking out a loan, a customer simply pays a monthly fee. This fee is intended to cover the cost of the solar system, as well as regular servicing and the replacement of essential components such as batteries and electronics. It seems an ideal customer offer, with the potential for high rates of diffusion. But in line with the theme of this book, the more worrying question is whether it can ever be successfully executed by entrepreneurs as a business model.

This gets back to our emphasis on agency in Chapter 2. It is not enough for solar to be made affordable and for service to be made available (fee-forservice will certainly do that): an entrepreneur must also be able to bring the capacities and resources together and deploy them in a profitable manner. If a strategy is so taxing that entrepreneurs and their businesses fail, then this leads to a delay in diffusion of the technology.

Various studies have found that, while a cash and credit set-up can serve up to 25 per cent of the rural unelectrified market, to get to 50 per cent you will need a fee-for-service approach (see Figure 7.10). For example, a study carried out in the Eastern Cape in South Africa found that very few people could afford the up-front costs of a PV system on a cash basis, but that roughly 50 per cent of the rural unelectrified population could afford 47 rand per month (US$7).24

Seemingly responding to such studies, the South African Government put in place a programme that charged the customer just US$25 at the time of installation and US$7 per month for as long as they used the system. All replacement costs - for example electronics and batteries - were to be included in the monthly service fee. If we compare this to the credit schemes we reviewed in Indonesia, for example, where customers paid $100 up-front and $12 per month for four years, we can imagine that fee-for-service would lay the foundations for a rapid diffusion of the technology. Moreover, in

Figure 7.10 The theory behind fee-for-service

Source: Eckhart et al (2003), p12

Indonesia, and the other countries profiled, customers were responsible for paying for their own battery replacements outside of warranty. So clearly the South African Government's scheme was a pretty good deal for the customer, and should have led to rapid diffusion.

This proved to be the case - at least initially. Under the South African programme, an Eskom-Shell joint venture took only three months to sell and install 6000 solar systems in 1999 - a truly unprecedented rate of diffusion. But by 2004, when Eskom and Shell exited, the number of customers served still stood at only approximately 6000. Other companies had also commenced operations under this programme, but by the end of 2006, none of these companies had significantly exceeded a cumulative base of 10,000 systems installed (compare this to Grameen Shakti in Bangladesh, which exceeded cumulative sales of 120,000 solar systems by mid-2008).

On the surface, this shouldn't happen. If a customer is paying a much lower down payment and monthly amount for a solar system, as in the case of fee-for-service, solar sales should ramp up very quickly. But this was not an isolated instance of slower than expected sales under fee-for-service. In the Dominican Republic and Honduras, for example, one of the early pioneers profiled in Chapter 4 deployed a fee-for-service model requiring the customer to pay US$15-20 per month, depending on the size of the system. Under this programme, 1500 systems were installed in the Dominican Republic and 2000 systems were installed in Honduras over approximately four years.25 But given that the aim was to quickly scale up to 25,000-50,000 households, diffusion was clearly moving slower than expected under the fee-for-service model.

Around the same time, a company in Morocco launched a similar fee-forservice business. Under the first scheme of its kind in Morocco, the company received exclusive rights from the Government to service customers in its designated territory using a fee-for-service approach. But after four years of doing business, the firm had reached only 4000 customers and was consumed with just trying to make an operation of this scale work - there was no commercial basis for increasing the number of installations beyond this level.

The American entrepreneur profiled in India also launched a subsidiary in Sri Lanka. Initially this firm had ambitions of doing fee-for-service, but after a trial run, the local team pulled the plug. Similar fee-for-service programmes in Cape Verde and Argentina, which the World Bank was at one point interested in supporting, also failed to take off. For example, in Argentina it seems that the number of systems installed between 1995 and 2002 under a fee-for-service programme was only 700 out of a total unelectrified market of 66,000 households.26

It has clearly been hard to make fee-for-service work, and the reason for this starts to emerge if we consider a few articles on the subject. For example, in an insightful article called PV 'power and profit?', it was questioned whether anyone doing fee-for-service in South Africa could ever make any money:

The companies will need to keep a real presence alive in the rural communities, and of course manage revenue collection - all in remote areas, far from major centres, and with poor road and telecommunications infrastructure. The service must be delivered at a fee affordable to the poor, yet sufficient to generate adequate returns on investment for the investors.27

And an article on 'lessons learned' by the World Bank concluded about the entrepreneur's efforts in the Dominican republic and Honduras that 'the firm is attempting to scale up the business model to 25,000 systems, but recurring overhead costs and slim profits make the expansion difficult.'28

Similarly, the findings from Sri Lanka were that 'one firm tried to operate a [fee-for-service model] for a while, but found the costs of monthly collections among the highly dispersed and remote populations to be high', and so they stopped doing it. Specifically, the firm had offered 140 systems on a fee-forservice basis, but as the organizer of the scheme confirmed:

Collection costs were eating up our entire profit margin. ... You need a strong fee collection system with good timing, otherwise customers will spend the money on something else, if your timing is off, and default. Or they will pay next month and ask us to wait, or cite poor performance. It's a continuing problem. Also, we found that if customers don't own the system, they won't take proper care of it and this increases our costs.29

When one steps back from it, the very idea of renting out high-cost equipment in difficult rural environments, and providing free replacement components for a monthly service fee, was a business model always bound to incur more costs. The 'cost' of running this business model is higher than selling on a cash basis, or even on a company credit basis. An entrepreneur will labour, and in most cases fold, due to six sets of costs that are higher under a fee-for-service model:

1 the cost of anti-theft, anti-tampering and meter-reading electronics;

2 the cost of theft of systems from customers' homes;

3 the cost of replacing components that customers tamper with or overuse;

4 the cost of regular follow-up to collect monthly dues;

5 the cost of churn, when customers stop paying and the system is removed; and

6 the cost of financing the higher capital needs of the business.

Many of these higher costs (points 1-5) come from the fact that what an entrepreneur is running is a rental model, where there is no ownership of the solar system by the customer in both a literal and metaphorical sense. Under a fee-for-service arrangement, a customer will have less incentive to prevent theft, or may even collude in theft; less incentive not to tamper with the system; less incentive not to overuse the system; and less incentive to make payment on time, or at all, because if the system is removed, the equity lost is less. Without customer ownership, it becomes a lot harder and more costly for an entrepreneur to manage the business.

Furthermore, point 6 above represents a large and fundamental cost. Any business that receives less cash from a customer up-front will have much larger capital requirements. In simple terms, if a business sold a 50-watt solar system outright to a customer, it might charge $600 as an installed price. In that $600 revenue would be enough to pay its suppliers, cover its operating costs and give a return to investors on their investment capital. But if the same company now only takes $25 up-front for the same system, that means that less than 5 per cent of the required revenue comes in on day one - the other 95 per cent needs to be financed.

As we have seen, it has not been easy for entrepreneurs to raise sufficient capital in the early stages of growth. This was the case even for the entrepreneurs in India and Sri Lanka, who took the decision not to finance the system themselves. Now consider that, in addition to financing the establishment of a market infrastructure, an entrepreneur must finance 95 per cent of the solar assets he or she is putting in the field, and you have a very capital-intensive business. That is not necessarily a problem if there is a good return to be made on the capital. But as we have seen, fee-for-service proves to be a more costly business model to run in practice. Therefore, the proposition to investors is doubly worse - more capital but lower returns - with the net result that entrepreneurs find it even harder to raise the capital and diffusion will be delayed.

Once a government gets involved in mandating and supporting a fee-forservice programme, such as in South Africa, it will find itself subsidizing these higher costs. And in the case of South Africa, which I consider in detail below, this higher subsidy led to delays, ambivalence and ultimately a distancing of the government from this showcase project.

South Africa case study: Fee-for-service

In February 1999, Nelson Mandela, then the President of South Africa, launched in the Eastern Cape what was proclaimed to be 'the world's largest commercial solar rural electrification project'. The aim was to reach 50,000 unelectrified homes with solar in the Eastern Cape in just three years. The implementing business was a joint venture between Eskom, the national utility, and Shell. In theory it was the ideal combination of a utility with strong clout and local market knowledge and a large corporation with solar module manufacturing, capital and strong management skills.

But Eskom and Shell were part of a much bigger Government initiative. As early as 1997, the Department of Minerals and Energy (DME) had identified a number of unserviced areas for off-grid electrification of 300,000 rural dwellings.30 At this time roughly a third of the population - 15 million people - still had no access to electricity. The Government's target was to ensure that by 2010 it had achieved universal access to electricity, and solar took on a 'saviour-like status as the perfect solution for ensuring that electricity would be available in areas where the grid would not'.31

In January 1999, the Government put out a call for proposals, and six concessionaires were chosen to implement the off-grid solar programme. Each selected concessionaire would in theory have a 20-year concession, including a 5-year exclusive right to sell up to 50,000 solar home systems in their area. The chosen concessionaires included an impressive line-up of local and international players: the Eskom-Shell joint venture; Nuon RAPS, which combined a Dutch utility with a local South African company called Renewable Area Power Systems; √Člectricit√© de France (EDF) and Tenesa, a local module manufacturing company; Solar Vision, a local solar player supported by SolEnergy, a Norwegian module manufacturer; Renewable Energy Africa, a local solar company still looking for a partner; and BP, which later pulled out of the programme before it commenced.

All the ingredients for rapid diffusion were in place. The Government had succeeded in attracting big players for investment in a rural market infrastructure to deploy solar in remote areas, and it was putting in place significant subsidies to make systems affordable to the customer. The implementing firm was to receive R3500 per system (roughly US$500 at the time the project commenced) as a grant to cover the capital costs of the solar system, the rationale being that with the capital costs of the solar system largely paid for, the business could then survive on collecting a much lower monthly rental. The designated monthly rental was R58 (roughly US$7) -significantly lower than, for example, the unsubsidized programme in Honduras, where customers paid up to $20 per month. With strong private players, a low monthly fee and provisions for after-sales service, large-scale diffusion looked to be assured.

But the reality proved to be very different. By 2002, just over 7000 systems had been installed, including 6000 by Eskom-Shell prior to the official launch of the programme.32 By 2004 this had gone up, but not significantly: to 19,000 solar systems. But questions were now being asked about the viability of the programme. In the Johannesburg Business Day, a headline read, 'Lights go out for off-grid energy projects'. And DME officials were now publicly backing away from the 300,000 target: 'We are no longer married to the number.'33

So what happened? Why did a project that was once the pride of the South African Government, deteriorate to such an extent?

There was, of course, a strong sense of needing to correct past injustices in South Africa, and solar was initially seen as a means of doing so when it came to rural electrification. As such, the Government tried to ensure all rural customers would be served as quickly as possible, and that all of them got the best deal possible. Although understandable, the Government was trying to shoot the moon.

First, to ensure that more homes received service more quickly, the Government took the step of carving the country into concessions. The idea was to give the private sector a monopoly to encourage it to enter and to invest heavily in serving the population. But inevitably, once the Government took this step, they had created a monopoly that needed to be regulated. And once it was regulated, it inevitably meant the project would become politically charged, with the private-sector operators and Government officials regularly butting heads throughout the process.

Second, because the Government was seeking the best deal possible for its people, it sought to control the prices and keep them low. As we saw, it set them considerably lower than, for instance, a private-sector fee-for-service initiative in Central America. But once it did this, it essentially meant that a very high subsidy had to be offered to facilitate these prices. Because the subsidy was so high, and because that subsidy even increased as the project went along, it made businesses highly dependent on the Government's every move. And because the subsidy was high, the programme became highly politicized, with considerable internal squabbling, making the Government less able to provide a clear and consistent policy framework.

From the announcement of the project in 1999, it would take nearly three years for the formal contracts to be signed with the concessionaires. During this time there was intensive wrangling, because the rand had devalued, and the original subsidy amount of R3500 was worth less in US dollar terms - only US$292 at the worst point in the rand's fortunes, compared to the intended amount of US$500. Whereas the subsidy was meant to have covered the capital cost of the solar system, now firms were left covering some of the capital costs in addition to their operating costs.34

With pressure from the implementing firms for a higher subsidy, officials within the DME started to become irritated with the perceived intransigence of the private sector, and started to question the project - was it worth the high subsidy and the hassle? In the end, instead of offering a contract for 10 or 20 years, the DME offered an interim contract for 18 months - from mid 2002 to the end of 2003, later extended to the end of March 2004. While this provided short-term relief, it was far from the clear, long-term policy framework to incentivize significant investment from the private sector in their concessions. How could a business invest in the infrastructure, the inventory, the receivables and so on if it did not know whether there were sufficient subsidies to continue the business beyond two years?

Further in-fighting then occurred between the National Electricity Regulator (NER) and the DME.35 The result was that the NER placed a cap of 300 systems per month until the end of March 2004 across all the concessions. After complaints by the concessionaires, the NER managed to find some interim funds to keep the programme going, but further damage was then done when, in January 2004, the DME announced that once the NER money was exhausted, there would be no further subsidies from March 2004 onwards, until a review of the off-grid solar programme had been completed.

Adding yet further uncertainty was the parallel political issue that the monthly service fee of R58 per month (US$7) was no longer politically viable. Under a broader measure, the Government announced that all consumers of electricity would receive the first 50 kilowatt hours (kWh) of electricity for free. This made the position of the solar programme untenable, as customers were receiving only 6 kWh per month for R58.

So in July 2002, the DME announced that, in addition to the existing subsidy of R3500 per system, a further subsidy of R40 per month would be added to reduce the monthly costs paid by each customer - so that customers would only pay R18. But again, this proposal was riddled with uncertainty. The DME asked the concessionaires to do this on a pilot basis, but of course this had huge risks. How could a business reduce the price to R18, on a pilot basis? Once reduced by such an extent, customers would not easily allow a business to increase the price back to R58 once the pilot was over.

Moreover, it was not clear that this subsidy would actually be made available, as under constitutional reforms on decentralization of government, the concessionaires now would have to go to multiple municipal governments to collect this operating subsidy, rather than to one point (the DME). These municipal governments, newly formed, were not even clear on the number of customers in their region with solar, let alone supportive of solar in the first place, largely preferring their electorates to have the grid.

With such uncertainty and lack of clear policy direction, Eskom exited in 2004, followed by Shell Solar. The other concessionaires remained, but it was now largely down to three players - NuRa (Nuon RAAPS), EDF and Solar Vision. They continued, and persevered, but by the end of 2006 they were still facing an uncertain subsidy environment, and their numbers of installations were far from the target of 50,000 systems per concessionaire over five years (Table 7.5).

Table 7.5 Annual solar systems installed by company under South Africa's fee-for-service programme


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    What is the feeforservice system in the Republic of South Africa?
    8 years ago

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