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This is a personal blog. Although the authors are affiliated with Coda Payments, the views expressed here are their own.

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Thursday
Oct182012

Value creation is changing. MNOs aren’t

MNOs are obsessed with profitability. Every new product, bundle, tariff, package, or service needs to have a business case signed off before it’s released to the market, as does every new capital expenditure.

That sounds sensible. MNOs are businesses, and their shareholders ought to be happy that management is so scrupulous in trying to ensure that every move they make will be a profitable one.

But a funny thing has been happening in the information economy. All the great “over the top” players have made losing money—enormous amounts of it—an integral part of their business model. 

Google is probably the most obvious example of this. By and large, Google makes money by charging advertisers to display ads; 96% of its revenues in 2011 came from advertising. They give away, for free, virtually all of their consumer-facing products: Search, Gmail, Google Docs, Google Maps, Android, and so on. Similarly, Facebook charges its users nothing to use its platform and makes its money selling ads.

The phenomenon is not confined to ad-driven business models. Apple makes money—a lot of it—selling hardware. But then it gives away software (have you downloaded iOS6 yet?) and earns only paltry profits distributing content through iTunes relative to its hardware business. Amazon’s strategy is to do the reverse, selling the Kindle family of devices at cost but then profiting from all the content purchases that customers make using it.

An economist would note that giving all this stuff away generates significant consumer surplus, which just a technical way of saying that many customers would likely pay if they had to. In other words, these companies deliberately and consistently leave money on the table in huge swathes of their business. This is of course not because the bean counters in these organizations are asleep at the switch. Google didn’t forget to charge for Gmail. Rather, Google’s management reasons that it can make more money selling ads to a large number of Gmail users than it can collecting fees from a smaller number of paying Gmail users. A version of this simple math is what has led these tech giants to underprice many of their offerings, with the objective being to drive growth in the core profit-making parts of their businesses.

MNOs don't really do this. It's true that some investments in mobile money have been justified in part by its potential to increase customer loyalty (either reducing churn or increasing ARPU), but when you look closely at the ways these services are priced you will see a slavish dedication to ensuring gross margin profitability on every transaction (pdf). 

Given that MNOs increasingly see these over-the-top giants as competitors, it’s interesting to ask whether they could learn something from this kind of strategic cross-subsidization. What do you think? What, if anything, should operators give away?

Tuesday
Oct092012

What does the appointment of Raghuram Rajan auger for mobile money in India?

India-watchers the world over have been cheered by Prime Minister Manmohan Singh's appointment of Raghu Rajan as India's chief economic advisor. Rajan, a professor at the University of Chicago, might be the most famous economist in the world for having predicted, three years in advance, the 2008 financial crisis and its causes.

Rajan is outspoken about India’s need for reform. In an April graduation speech, he was unsparing in his critique of India's government and governance. "The government does too much of what it should not do, too little of what it should do, even while being capricious and unaware of its limitations." He had this to say about those limitations, and while he wasn't talking about the Reserve Bank of India's approach to payment-system regulation, he might have been:

Our government is often unaware of its limitations. There is a lot we could learn from the rest of the world. China does not feel threatened by new information—it gets the best experts in the world to offer it advice, then it picks what it is persuaded by. Yet Indian administrators, apart from a few open-minded ones, feel threatened by new ideas. India is sui generis they maintain—that is, it is in a category of its own. So it has nothing to learn from the outside, from the Indian diaspora, or even from its own private sector. Whether this is a matter of convenience, allowing administrators to pursue their vested interests, or whether it is intellectual laziness, is unclear. Nevertheless, we keep repeating failed experiment after failed experiment, ignoring what has worked around the world.

Rajan, who calls "improving our financial markets and financial institutions" his "pet interest," has made no secret of his view that the Indian banking sector is sclerotic and subject to insufficient competition. For a sense of his views on what India needs to advance financial inclusion, we can look to a 2008 report by the Committee on Financial Sector Reforms, which Rajan chaired.

We see inclusion… as expanding access to financial services, such as payments services, savings products, insurance products, and inflation-protected pensions…. The focus should be on actually increasing access to [these] services for the poor regardless of the channel or institution that does this—large banks may or may not be the best way to reach the poor.

The report goes on to speak approvingly of the emergence of mobile money in Kenya and the Philippines, and explicitly poses the question of whether nonbanks should be permitted to offer payment services.

The Committee recommends that the regulator actively explore the channels by which non-traditional entities with extensive low cost networks (e.g., post offices), regular contact with the underserved (e.g., kirana shops, cell phone companies) or with some leverage over potential borrowers (e.g., buyers of produce, sellers of inputs such as fertilizers) could be used to provide financial services in a viable manner. While the business correspondent model will be one way these entities can link up to the formal financial system, the larger question, however, will be whether some non-traditional entities can directly and independently provide regulated financial services. For instance, should cell phone companies be able to offer account-to-account transfers without going through bank deposit accounts? The answer to these questions should be based on what is the most efficient way to provide services while imposing tolerable levels of systemic risk. Some of the new non-traditional players may be large and well capitalized (e.g., cell phone companies), and may therefore add less risk to the system than the existing reliance on some financial entities.

Why delve so deeply into the views of a man who, while no doubt influential, is taking up an advisory role in a country where so much of policymaking is shaped by the vagaries of politics? For one simple reason: the New York Times calls Rajan the leading candidate to replace Duvvuri Subbarao as head of the RBI when his term expires next year. Governor Subbarao has been an intractable opponent of allowing nonbanks to offer robust payment services in India, despite the mounting evidence that mobile operators in particular are uniquely well positioned to offer compelling payment services to the poor. To borrow words from Rajan, "whether this is a matter of convenience, allowing administrators to pursue their vested interests, or whether it is intellectual laziness, is unclear." But what is clear is that Rajan would bring a radically different approach to RBI. And that, in turn, would auger well for access to financial services for India's poor.

Tuesday
Oct022012

How direct deposit, or the absence of it, shapes financial lives

In conversations about the future of banking in the developing world, it is taken as almost a given that bank branches as we know them will disappear, or at least be radically transformed. The idea is that with the power of new channels that give customers the ability to carry out many of the operations they previously carried out at branches, and with widespread ATM networks that offer easy access to cash, bank branches will simply become less important. Many of us find this plausible because we hardly ever visit bank branches anymore ourselves.

In the developing world, though, the expression “branchless banking” doesn’t have the same connotation.  Although mobile money and agent banking make it possible for customers to cash in and cash out outside of bank branches, no one views this as a substitute for branches themselves. This is in part because branches remain important as sales channels; it is also because branches very often come to serve as the hubs through which the cash that is collected or disbursed by agents flow.

What explains this dichotomy? Direct deposit. In fact, direct deposit explains many of the most fundamental differences between mature and developing financial systems.

Direct deposit is the American term for employers paying salaries directly into employees’ bank accounts. Because this is very widespread in the developed world, consumers rarely have a need to cash in—their salary, their primary source of liquidity, flows directly into an electronic account on a regular basis. This is why we can contemplate the reduction in the number of bank branches (which are really the only place to convert cash to digital form) with equanimity. In the developing world, only a small fraction of household earnings are paid into bank accounts, which means more people earn in cash and need bank branches (or agents) to make deposits.

Another implication of direct deposit is subtler. Banks often offer customers a better deal on deposit accounts when they are paid by direct deposit. At mine, for example, Citibank waives its recurring monthly fee for customers who are paid using direct deposit, because it can monetize the float that will inevitably appear in those accounts at regular intervals. This allows salaried employees to enjoy the many conveniences of modern banking (online bill payment, for example) for free. No such subsidies exist for most customers in the developing world, which is why transactional accounts (whether they are bank accounts or stored-value accounts) are characterized by a welter of fees.

Finally, direct deposit shapes customer behavior at retail. Customers like being able to pay for goods and services using debit cards not because it is faster than cash (I’ve timed it, and it’s not) but because, if you’re paid by direct deposit, it’s easier—it eliminates the need to stop off at an ATM in between being paid and making purchases. (Thought experiment: if you were paid in cash, would you buy a pre-paid debit card each week so that you could use when shopping? I doubt it.) So direct deposit is a major driver of card usage at retail. In contrast, as Ignacio Mas has noted, persuading customers in the developing world to use a digital payment instrument at retail instead of cash will be an uphill battle, because you’re forcing them to jump through an extra hoop: cash in.

Of course, the chain of causality doesn’t stop at direct deposit. It goes back even further, to patterns of employment. In the developed world, most people earn a regular salary from a formal employer that has the capacity to pay using direct deposit. In most poor countries, this is not the case. This is one of the reasons why most schemes to get salaries paid into mobile money accounts have failed. A very different kind of direct deposit will be needed for it to make sense for the highly fragmented universe of often informal employers who pay salaries in every low-income country.

Until that day, the retail experiences of consumer banking will continue to diverge in the developed and developing markets, and “branchless banking” will continues to mean different things depending on where in the world you are.

Monday
Sep242012

The biggest unlicensed e-money issuers in the world?

In my last post I wrote about the interesting range of payment services that, while they have outgrown their closed-loop origins, are nevertheless not regulated as full-blown e-money services.

My favorite examples of this are frequent flyer mile programs. At first blush, frequent-flyer programs seem so limited in purpose—by flying with an airline, you accrue the right to free flights with that airline—that to talk about them as payment systems seems a stretch. But dig deeper, and you find that frequent flyer programs have many of the hallmarks of open-loop payment systems. Consider:

  • You can “cash in” by buying miles.  Most frequent flyer programs allow their customers to buy miles (the “currency” which most frequent-flyer programs issue) using cash, and they promote this option when customers are shopping for reward flights but fall short of the number of miles needed to purchase their chosen itinerary. Less evident to consumers, but far more common, is the practice of selling frequent flyer miles to companies (mostly banks) who offer frequent flyer miles to customers who use their services (mostly credit and debit cards). In 2012, Citibank spent over US$1 billion buying frequent flyer miles that it doled out to its cardholders.
  • You can transfer miles from one person to another. Most airlines allow this within their programs, for a fee. A few years ago, a company called Points.com made a valiant effort to create a platform where customers could transfer miles from one program to another, but the airlines permitted this only at usurious exchange rates, as anyone who has studied the competitive dynamics of interconnection would expect.
  • You can purchase a variety of goods and services, not just flights, using miles. When I lived in the States, I was bombarded by direct mail solicitations inviting me to use my miles to purchase magazine subscriptions. Many US and European airlines also make it possible for their customers to redeem miles for hotel stays, rental cars, and other travel-related goods and services.
  • You can “cash out” by converting miles into cash. At the aforementioned Points.com you can transfer convert miles into dollars and have them deposited into your PayPal account; an alternative is PointsPay.com, which allows you to make a similar transaction and load up a pre-paid debit card with the proceeds.

So are regulators asleep at the switch? Are the airlines actually crypto-e-money issuers that have evaded regulation simply by using the unit of “miles” rather than local currency to evade their proper compliance obligations?

I don’t think so. Customers are under no false pretenses about who controls the value of their frequent flyer miles: the airlines. They know this in part because the airlines have been stoking inflation in the mile economy for years, steadily making it harder and more costly to redeem miles for flights. Many frequent travelers (myself included) view mile accrual as a means to elite status, with its attendant lounge access and upgrades, not award flights. Customers also know that frequent flyer miles expire.

Finally, frequent flyers are well aware of what would happen to their miles were their airline to go belly up. When airlines go out of business (which, given the industry's abysmal profitability, they do with some regularity), the frequent flier miles they issued to customers disappear, too.

This suggests, I think, one useful way of distinguishing between services which ought to be regarded and regulated as e-money issuers and others that shouldn’t. E-money issuers make a promise to customers that their money is safe, won't expire, is tethered to a national currency, and will be refunded to them even if the issuer itself goes bankrupt. The issuers of reward currencies make no such guarantees. Regulators should insist that this distinction is made clear to customers--and then leave these services to extend their usefulness in innovative ways. 

Wednesday
Sep192012

What lies between closed-loop and open-loop payment systems?

Around the world we see two very different kinds of payment systems that permit the storage of value in accounts other than traditional bank accounts. One is a so-called closed-loop system, in which customers are able to spend value they’ve deposited into their account only for goods and services offered by the provider of that payment system; usually, it is impossible to redeem this value for cash or transfer it to someone else’s account. Gift cards, transit (e.g. Oyster) cards, Starbucks cards, and so on fall into this category. Schemes like this tend to be very lightly, if at all, regulated, since it is hard to exploit them for money laundering or terrorist financing; they pose few systemic risks; and, since customers are unlikely to store large sums in them, scant attention is given to the question of whether customers will be able to get their money out of the system in the event that the provider becomes insolvent.

Open-loop payment systems, on the other hand, allow customers to spend value deposited into them at multiple merchants, transfer it to someone else, and/or withdraw it as cash later. Mobile money, pre-paid debit, and other e-money-based systems fall into this category. They are more heavily regulated, because these systems can be used to launder money; they can (if they grow large) pose systemic risks; and policymakers often feel that, if customers are told that they will be able to withdraw their money, then safeguards should be put into place to ensure that they will always be able to do so.

But although these two kinds of systems are regulated as discrete models, they are in fact situated on a continuum, and there are many interesting hybrids in between. Many supposedly closed-loop systems are not so closed in practice, and indeed there are strong commercial pressures on the providers of closed-loop services to open up by incrementally expanding the range of functionality they offer customers. A classic example of this evolution is the Octopus card, which was introduced as a way to pay for mass transit but can now be used to make purchases at retailers all over Hong Kong.

This is in part because it is easier for a lightly-regulated closed-loop system to incrementally add functionality that edges them along the spectrum toward openness rather than it is to seek regulatory approval to transform into fully-fledged open-loop service provider or to start a new such system from scratch. By adding the ability for customers to send airtime to each other on their networks, for example, mobile operators in a number of countries inadvertently created an unofficial domestic remittance system that has never become formally regulated as such.

This poses challenges for policy makers, who can either block these new hybrid models and the enhanced functionality they offer customers or find ways of coping with their emergence. RBI has drafted a framework for regulating “semi-closed” and “semi-open” payment systems, but rather than using these categories as a way to accommodate emerging service models, it has instead offered them as rigid prescriptions for what functionality may be offered to customers by systems that are regulated in each category. As such, it does little to foster the emergence of useful new open characteristics of closed-loop systems, which, after all, can benefit consumers, including the financially excluded, in interesting ways.

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