Optimal Grants and Subsidies for Development Supply Chains: Case of Solar Lanterns in Haiti

Abstract

Problem definition: In supply chains for subsidised products sold to low income families, there is a question about who should be subsidised in the supply chain and to what extent, and whether retail competition or having substitutable products matters. Academic/practical relevance: By introducing and analyzing “development supply chains” in which transactions are commercial but grants and subsidies are needed for affordability, we show that donors such as USAID or World Bank need to understand and exploit supply chain structure, including retail competition and product subsitutability. Methodology: We develop stylised models to analyse optimal grants and subsidies for a three-echelon supply chain of manufacturers, retailers and consumers. Successive models focus on manufacturers and grants, and on retailers and consumers, adding substitutable products and competition in retail. Results: A “lump-sum” grant enables the donor to generate an indirect incentive for the manufacturer to make R&D investment to reduce its own unit cost and a direct incentive to reduce its wholesale price for retailers. The donor can subsidize either the retailer or the customer, and the total subsidy per unit has an optimal level. Having choice between a more preferred and a less preferred substitutable product can increase the number of beneficiaries. Subsidizing competing retailers can increase the number of beneficiaries although at the expense of reduced margins (but higher units sold). In all cases, margins for the retailer echelon remain positive, supporting the “development” goal. Managerial implications: Donors must coordinate within different programmes along the entire supply chain. They must encourage substitutable products with support for higher quality, higher cost products as well as retail competition. Unit subsidies to the retailer, micro-entrepreneur, or customer are economically equivalent, so transaction costs should drive the decision for where to subsidise the supply chain.