Two Trends Investors Should Be Watching in Kenya

By: Niki Kidd, Investment Fellow @ VestedWorld and Kellogg MBA Candidate, ’17

For 10 weeks this winter, I’ve had the amazing opportunity to work with VestedWorld as part of the Kellogg School of Management’s Venture Lab class. In addition to assisting with deal pipeline assessments and company due diligence analysis, I was asked to develop my own investment themes within Kenya. I spent weeks researching and assessing the current and future opportunities within the Kenyan entrepreneurship landscape. First, the TL;DR recap of the current state in Kenya:

· Agri-business is still king in Kenya, but food loss and lack of distribution networks are stifling economic growth

· Looming population boom comes with opportunity and challenges, both within Nairobi and beyond

· Multinational firms are still struggling to enter these markets, but globalization tendencies can guide strategic decisions

· While Kenyans have leapfrogged some traditional technology advancements, it is important to meet them where they are when considering launching new products and services

From this starting point, and in considering the current firms within the VestedWorld pipeline, two major investing themes emerged: a focus on the demand side of agri-business outputs, and identifying companies with the ability to leverage massive urban population expansion.

Diverting Farm to TableA Renewed Focus on the Demand Side of Agri-Business Outputs

Supply side improvements in the agricultural business value chain have been a main focus of investments and entrepreneurship in East Africa. But this approach misses an equally important factor within this chain — the demand side of these outputs. By focusing on companies diverting outputs from their current distribution channel, either through funneling produce to canning, preservation, or long-term cold storage; or through disrupting the distribution channel itself, there exists a tremendous investment opportunity for VestedWorld and other funds like them.

Food loss is a considerable concern within the agri-business value chain.[1] Estimates indicate that over 30% of primary production is lost between harvesting and the marketplace, a huge drag on the Kenyan economy. Farmers are unable to realize the full value of their products and end users have limited access to fresh, quality produce at their marketplaces. Additionally, with expected population growth throughout the country of about 5% per year, significant investments to drive an increase in outputs would be necessary to match demand; any advancement or improvement in food loss rates would be imperative to limiting food scarcity.

Reasons for primary production loss are numerous, and include infrastructure inefficiencies, lack of access to appropriate storage and vampiric middlemen. Infrastructure improvements play a major role within the 2030 Goals[2], national priorities established to improve the Kenyan economy to the point of being considered a middle-upper income economy. These improvements will largely be executed at a governmental level (vs. individually by entrepreneurs) but serve as an important backdrop for investments within this part of the value chain.

Beyond produce, livestock production, distribution and consumption will be a significant market opportunity in the next 5–20 years in Kenya. With staggering growth in population on the horizon, increasing urbanization within Kenyan cities and rising incomes, livestock consumption is estimated to increase significantly within the coming years. Three-quarters of the potential growth in food production could be consumed by meeting intra-African demand and substituting imports of manufactured goods, which today are at levels much higher than in peer regions.

Distribution and access to markets for farmers is crucial.[3] Pastoralist producers currently incur very large transaction costs. They are able to collect only 40–50% of gross livestock sale value and to realize only 5% net returns on their marketing and herding investments.[4] This “dead weight cost” is the result of inefficient supply chain structures and serves to keep a large proportion of producers out of the market. There appears to be considerable untapped potential to therefore connect poor producers with consumers, including poor consumers, offering benefits to both sides of the marketplace.

Distribution and access to markets for farmers is crucial. Pastoralist producers currently incur very large transaction costs. They are able to collect only 40–50% of gross livestock sale value and to realize only 5% net returns on their marketing and herding investments. This “dead weight cost” is the result of inefficient supply chain structures and serves to keep a large proportion of producers out of the market.

With export challenges common across the region, connecting farmers with the growing local middle class is therefore critical, and can be done through two strategies — better storage and creation of new products. Cold-storage facilities are one of the bottlenecks to better market access, as there are limited facilities available to store food; at this point, only 16% of wholesalers have cold storage near marketplaces.[5] While potentially a large, capital-expenditure-heavy business, finding firms willing to take this investment and tap into the large retail and grocery opportunity in growing cities will create significant value. Second to this is creating new products, specifically through canning or preserving fresh fruit and vegetables. While dependent on customer tastes and behaviors, opportunity exists to take greater agricultural outputs and put them to use to create new, exciting flavors within the FMCG space.

Betting on Urban Development — Identifying Companies Poised to Leverage Massive Urban Population Expansion

Kenya, like many other countries across the African continent, is set to experience a population boom in the next 10–40 years. Cities of over 5 million residents will exist across the continent and Kenya, with vastly different infrastructure, food, distribution, and financial needs. While companies assisting and connecting the rural communities, oftentimes with a focus on bottom of the pyramid customers, have been a focus for early-stage investment in Kenya in the past, this new urban reality provides an immense opportunity for both entrepreneurs and investors.[6]

This urban explosion, and the potential for profitability, is currently hindered by a lack of housing options. Affordable, reliable housing will be an extreme challenge to meet during this time. With current population growth estimates, Nairobi requires at least 120,000 new housing units annually to meet demand, yet only 35,000 homes are built, creating an 85,000 unit deficit per year.[7] Because of this supply and demand mismatch, housing prices have surged 100% since 2004. Coupled with the fact that demand side of housing, specifically in regards to end-user financing, is also limited, it is no surprise that 60% of urban Kenyans live in slums. Kenyan officials are attempting to address this through recent policy changes, including promotion of compact residential neighborhoods for optimal use of land and development of family and single person dwellings to address house shortages.[8] Without housing advancements, the push towards the middle-income country that Kenyan leaders are striving for will be extremely difficult.

With current population growth estimates, Nairobi requires at least 120,000 new housing units annually to meet demand, yet only 35,000 homes are built, creating an 85,000 unit deficit per year. Because of this supply and demand mismatch, housing prices have surged 100% since 2004.

On top of housing needs, mass transit system development, especially one that is not reliant on individual automobiles, is similarly imperative. Nairobi is on the global index[9] of top ten most painful cities for commuters, and that is only set to get worse. The current system of matatus, developed in the wake of the collapsed public transportation system in the 1990’s, brings new meaning to the word informal.[10] And a recent rapid bus expansion project was scrapped due to logistical challenges, despite $300M from the World Bank and the recent success of DART in Dar es Salaam.[11]

72% of Nairobians commute to work and 24% use matatus; almost everyone else walks, limiting job opportunities to 8% of the total city. Alternative travel opportunities are sprouting, but without significant traction to prove a business case. OpenIDEO is attempting a bike share program[12], partnering with the local university[13] and building on other successful efforts in Uganda with Bicycles Against Poverty.[14] Innovation within the transportation space will be vital to the future success of the Kenyan economy.

Understanding that major infrastructure advancements, like the ones necessary based on the above research, are best met by government agencies, how can investors and entrepreneurs take advantage of this coming population and infrastructure expansion? One area is in brick and mortar retail locations. With land prices skyrocketing, there are few opportunities of individual entrepreneurs and investors to make a significant land grab; as such, the prominent advice being followed in the region is to develop, not sell land. Part of this development is likely to be retail outlets; for companies with the ability to invest to expand a physical presence in these areas, and who have political and economic relationships to help with any potential road blocks, a savvy entrepreneur could create significant value while riding the coat tails of other developments.

Beyond brick and mortar retail, these large cities will also have an incredible amount of new customers to service from a CPG and FMCG perspective; not only in what they are purchasing, but how they are purchasing. A recent Oxford Business Group[15] survey found shifting consumer trends have driven growth in the formal retail segment, with 30% of Kenyans now shopping formal outlets (compared to 4% in Ghana, and 2% in Cameroon and Nigeria). The rise in formal outlets is in part a result of increased availability in terms of dedicated retail property. Kenya’s largest and most prominent shopping centers are presently concentrated in Nairobi and include the 46,451 sq-meter Sari Centre, the 32,516 sq-meter Westgate Mall and the 23,783 sq-meter Junction Mall.

A recent Oxford Business Group survey found shifting consumer trends have driven growth in the formal retail segment, with 30% of Kenyans now shopping formal outlets (compared to 4% in Ghana, and 2% in Cameroon and Nigeria).

It is also important to consider what cities will look like outside of Nairobi. Following Nairobi, traditional alternative economic powerhouses of Mobasa, Eldoret, and Kisumu have received much attention, however developers are increasingly looking to other counties to capitalize on rising incomes and consumerist tendencies. Taking the recent precedent in Tanzania[16], while Dar es Salaam is the financial hub, four other cities (Mbeya, Arusha, Mwanza, and Zanzibar) are emerging fast due to growing populations and thriving economic activities. This “Second Cities” hypothesis for Kenya is extremely likely, and could include Isiolo, Kisii, Malaba, and Thika, amongst others. Looking at banks as a potential indicator of development, Kilifi is also an interesting urban opportunity, with 7 banks in the region and access to airports and seaports for import and export opportunities.[17] A majority of firms currently receiving investor money within Kenya are Nairobi based; finding entrepreneurs taking chances in other growing metro areas could be an additional competitive advantage for creative investors.

Finally, one of the last key opportunities that touches across many of these urban demands is one of financing — from mortgages (market expected to grow 13x)[18], to joint-purchase land loans, to retail credit (owners and customers), there is a huge opportunity to capitalize on these financial realities. To ensure that these markets continue to grow, customers will need to be able to pay for assets; how they do so, beyond the simple and oftentimes informal methods used currently, will be another interesting bet on urban development.

Where Else Should Investors Look?

Beyond the two themes discussed, many other economic, competitive, demographic, cultural, and political contexts needs to be considered when assessing investment opportunities within Kenya.

Two of these contextual areas warrant a heightened level of attention: large multinational firms’ (“MNIs”) activities (or, in some sectors, lack thereof) in the region, and changing (or not) consumer preferences for domestic vs. imported goods.

Six industries also warrant additional attention, including wholesale & retail, food & agri-processing, health care, financial services, light manufacturing and construction.[19] These sectors are fragmented — consolidation could unleash more opportunity for corporate Africa.[20] Health Care and food & agriculture are both especially fragmented, where in each the top three firms combined add to no more than 25% market share.

What’s Next

It’s been an honor to work with VestedWorld and to get the opportunity to learn more about this dynamic and exciting investment landscape. It is obvious that opportunities abound across Kenya for the smart, strategic and bold entrepreneur and investor. With a major industry at the precipice of disruption, and a booming population on the horizon, investors willing and able to commit significant and patient capital to earlier stage firms could not only see significant returns on their investment, but also have a real impact on entrepreneurs and communities too often ignored by traditional capital.

[1] https://www.rockefellerfoundation.org/app/uploads/Waste-and-Spoilage-in-the-Food-Chain.pdf

[2] http://www.vision2030.go.ke/

[3] http://www.lrrd.org/lrrd25/3/rutt25042.htm

[4] http://www.economist.com/news/briefing/21694521-farms-africa-are-prospering-last-thanks-persistence-technology-and-decent

[5] https://www.ft.com/content/c1f2856e-a518-11e3-8988-00144feab7de

[6] https://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/AEO_2016_Report_Full_English.pdf

[7] http://acumen.org/wp-content/uploads/2013/03/ABCs-of-Affordable-Housing-in-Kenya.pdf

[8] http://www.nation.co.ke/news/Big-changes-revised-urban-policy/1056-3126324-11l3qv0/index.html

[9] http://www-03.ibm.com/press/us/en/pressrelease/35359.wss

[10] https://www.theguardian.com/cities/2014/feb/19/cities-motion-how-we-mapped-matatus-nairobi

[11] https://www.theeastafrican.co.ke/business/Kenya-retreats-on-rapid-bus-transit-plan/-/2560/3221604/-/10gm01i/-/index.html

[12] https://stories.openideo.com/designing-kenyas-first-bike-share-program-f243b48288b7#.yruk3ulri

[13] https://www.ft.com/content/6133a0f0-5a5b-11e6-8d05-4eaa66292c32

[14] http://bicyclesagainstpoverty.org/

[15] https://www.oxfordbusinessgroup.com/overview/bright-outlook-improving-economic-conditions-and-changing-consumer-preferences-point-strong-years

[16] https://www.howwemadeitinafrica.com/big-business-potential-in-east-africas-smaller-cities-and-towns/

[17] http://www.kuzabiashara.co.ke/blog/small-town-biz/

[18] http://acumen.org/wp-content/uploads/2013/03/ABCs-of-Affordable-Housing-in-Kenya.pdf

[19] http://www.mckinsey.com/~/media/McKinsey%20Offices/South%20Africa/PDFs/Rise_of_the_African_consumer-McKinsey_Africa_Consumer_Insights_Center_report.ashx

[20] https://www.brookings.edu/wp-content/uploads/2016/07/kenya-country-case.pdf

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