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


How glib talk slows financial inclusion

A blog post appeared on FT Alphaville yesterday purporting to draw lessons from the case of M-PESA in Kenya that are relevant to the Eurozone’s woes. Unfortunately, by confusing some key points, its author unwittingly plays into the hands of those who would slow the expansion of access to financial services in markets where the unbanked are most in need of it.

Apart from misleadingly blurring the concepts of pre-paid mobile airtime credit and e-money, the most important mistake in the post is the assertion that “while Safaricom could theoretically reduce or increase M-PESA money as it see fits, it currently chooses to provide exactly what its customers ask for—providing, of course, that the correct collateral is delivered (Kenyan shillings in this case).”

In fact, Safaricom makes no such choice. Rather, it is obligated by the Central Bank of Kenya to create e-money only when “collateral” is provided to it, and to destroy e-money when that collateral is withdrawn from the system. This is how regulated e-money services work all over the world. They have been designed this way in large part to ensure that customers always have recourse to their funds, which are held in trust, even if the service provider in question were to become insolvent. This also keeps e-money tightly tethered to the national currency on which it is based.

Readers of this blog will already understand these points. They will also understand why it’s a big deal when a high-profile outlet like the FT gets them wrong.

As news of M-PESA’s impact has spread around the globe, mobile operators and others have sought authorization from their central banks to launch similar services. But in some cases their regulators have balked because they fear that such services entail the creation of money and could thus lead to loss of control over the money supply. This fear is rooted in a misunderstanding of the way e-money works, and advocates for financial inclusion have been working painstakingly for years to dispel it. The FT post is pernicious because it makes that work harder, not easier.

Update: A follow-up post, responding to some of the criticism of the original, has just gone up. 


Advertising won’t pay for content in the developing world. But consumers might

I was at a conference recently in Jakarta where 16 startups pitched their companies to a panel of judges. Most of the business models presented relied on advertising for revenue. They were no doubt inspired by the fact that most of the big consumer internet businesses in the US and Europe derive the majority of their revenue that way: Facebook, to take a prominent example that just went public with a market cap of more than US$100 billion, earns 85% of its revenue from advertising.

Unfortunately for these entrepreneurs and the end users they aspire to serve, there just isn’t enough money in online advertising in the developing and emerging markets for this to be a workable business model for most companies. A breakdown of Facebook’s own advertising revenues provides some evidence for this (see chart). Since Asia includes markets like Singapore and Japan, where ARPU is presumably more in line with European or North American levels, the delta between Facebook’s revenues in the developed and developing world is even more stark. And this is for Facebook, which dominates (and arguably depresses) the market for display ads. At the same conference in Jakarta, the CEO of the local portal commanding the biggest audience in Indonesia made approximately $50,000/month in ad revenue. That’s pretty small beer given Indonesia’s sheer size.

Why are their so many fewer ad dollars chasing eyeballs in the developing world? It’s simple. In mature markets, advertising spending tends to be 2-3% of GDP. In the developing world (where GDP itself tends to be smaller), this percentage is even lower, because disposable incomes are modest. Aside from the usual mass-market suspects (mobile operators and Coca-Cola), not a lot of firms spend huge sums on advertising—and what money there is often flows disproportionately into “old media”.

This means it’s prudent to be skeptical about advertising-driven business models in the developing world, which in turn means that it will be difficult for developers of local content and services—whether it be game developers or information service providers trying to make a business of offering farmers agricultural tips—to sustain themselves. This is the worm in the bud of Erica Kochi’s recent contention in TechCrunch that “the continued double digit growth of mobile in developing countries represents a tremendous business opportunity. While companies in Silicon Valley fight over trying to develop the top app in a certain category, huge untapped potential still remains in the developing world.” That huge untapped needs exist is manifestly true; it is the revenue potential of businesses that meet those needs that is questionable.

But—and this is important—ad-driven business models are not the only ones on the web or mobile web. Compelling content and services generate willingness to pay, and a number of online properties generate a significant fraction of their revenues this way. The problem is how to collect payments from customers. Interestingly, this problem spans developing and developed markets. For years, newspapers in particular have complained that the payments infrastructure in mature markets doesn’t allow them to collect micropayments for, say, single articles. Outside the developed markets, collecting payments of any magnitude from users online is a challenge.

This is one of the underappreciated reasons for why it is so important that we build inclusive payments systems in low- and middle-income countries: aside from all their other benefits, they may represent the best chance that would-be providers of online content and services are able to get off the ground.


In praise of Western Union (or, the catch-22 of doing business at the base of the pyramid)

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In his influential book The Fortune at the Bottom of the Pyramid, C.K. Prahalad argued that we should regard low-income people in the developing world not only as needy recipients of charity, but also as consumers whose lives could be enriched if companies would take them seriously as potential customers. This idea has rapidly become mainstream; for example, international aid agencies now devote considerable resources to encouraging the private sector to tackle problems that were historically seen as the domain of governments or NGOs.

Long before his book was published in 2005, Western Union had been practicing what Prahalad preached. Western Union offers a robust global remittance service that reliably handles billions of dollars each year ($76 billion in 2010 alone). It offers significantly better service levels than banks: transfers take minutes to arrive rather than days, and you can send and receive money from a staggering 485,000 agents around the world. Its fees are often lower than banks’, too. In exchange, Western Union commands a willingness to pay for its services that make it unusually profitable. (Its return on equity for the twelve-month period ending March 2012 was a staggering 193%.)

You might think that a company that millions of low-income migrants and their families around the world choose to handle their remittances would be the poster child for inclusive business, a case study on “doing well by doing good.” But of course, because it is so profitable, the reverse is the case. Western Union bears the brunt of an enormous amount of criticism for its “predatory” pricing.

Consumer advocates often argue for regulation of Western Union’s fees. But this, rather like interest-rate caps in microfinance, would be counterproductive. The best way to make Western Union lower its fees is to subject it to the discipline of the market by encouraging competition. Price caps have precisely the opposite effect, because they scare away potential competitors.

We have to get comfortable with the idea that companies with a competitive advantage over their rivals will sometimes generate excess returns at the base of the pyramid, just as, say, Apple has done when serving higher-income consumers. We should celebrate companies like Western Union, not demonize them, because by showing that there is a fortune at the base of the pyramid, they encourage others to seek their share of it.


Policy and the divisibility of the financial services value chain

In my last post I suggested one explanation for the fact that financial regulators have been reluctant to permit non-banks to offer mobile financial services: incentives that reward excessive risk aversion. Another reason, I think, is a failure to grasp the ways in which the value chain for financial services can and likely will be disaggregated over time.

The Governor of the Reserve Bank of India recently repeated his intention to permit only “bank-led” mobile financial services in India, explaining that, “Our experience shows that the goal of financial inclusion is better served through mainstream banking institutions as only they have the ability to offer the suite of products required to bring in effective/meaningful financial inclusion.”

I am not sure what experience he is referring to; in India, the use of mobile technology to extend access to financial services is still in its infancy. But even absent evidence, the argument is seductive: since banks can offer customers not just payment services, but also interest-bearing deposit accounts and personal loans, perhaps its best to leave outreach to them.

The argument founders, however, for the simple fact that the financial services value chain lends itself to disaggregation: non-bank payment providers cannot themselves offer banking products to their customers, but they can provide a cost-effective way for banks to distribute them. This is not a theory of what might happen; it already is happening. M-PESA customers in Kenya can easily access an interest-bearing savings account, a personal loan facility, and even a microinsurance policy offered by Equity Bank via the M-PESA platform, and 7 other banks in Kenya make it possible for customers to move money between their deposit and M-PESA accounts. As mobile money services gain traction, we will see many more of these arrangements emerge.

We must put to rest the fear that if customers sign up for a payment service, they won’t be able to continue up the “ladder” of financial inclusion—consigned to what one observer breathlessly called “poor quality, high cost, and potentially high risk financial inclusion.” This idea is not just wrong; it has also been profoundly harmful, because it has led a number of policymakers to deliberately frustrate the ambition of non-banks to offer payment services—postponing the day when the unbanked will get onto that ladder at all.


The regulator’s dilemma

For anyone interested in financial innovation in the developing world, a recent article by Nick Hughes, Gautam Ivatury, Jonathan Petrides, and Stuart Rutherford in Innovations is essential reading. It documents Signal Point Partners’ efforts to bring to market an innovative savings and loan product for low-income Kenyans using M-PESA. Although the service was a hit with customers, it was impossible to scale because a deposit-taking license was too time-consuming and costly for a new enterprise to acquire. The authors conclude:

The challenge is that only licensed institutions are permitted to take most financial services (and all savings products) to market. In other words, the very organizations that are narrowly focused on serving the most profitable high-income customers, hold the key to unlocking the potential of relevant digital services for the low-income masses—and they are the only entities licensed to so operate… In markets with lower barriers to entry, change can arise from disruptive new entrants with a focus on these untapped segments; however, as consumer deposits rightly remain a major focus for regulatory protection, innovation in financial services will continue to be inhibited as the changes required rely heavily on the incumbents.

Indeed, there is substantial resistance not just to allowing new entrants offering deposit-taking services, but even to allowing non-banks to offer basic payment services—a less risky proposition for which we now have very good regulatory templates. In a recent blog post for the World Bank calling on financial regulators to license e-money issuers, Ignacio Mas reiterates arguments that he has been making for years. Yet the post is still necessary because there are fewer than a dozen low-or-middle income countries where non-bank payment providers are allowed to operate. (Congratulations to Namibia for having recently joined their ranks.)

We seem to be stuck. But why? I would point to a problem with incentives. Most regulators are far more worried the downside risks that financial innovation entails than the potential upside. If you approve a new service provider that might end up defrauding customers, you put your reputation and possibly your career on the line. (If you get lucky and you approve, say, the next M-PESA…. well, it’s probably the next M-PESA that’s going to get all the glory, not you.) On the other hand, simply preserving the status quo by saying “no” eliminates the possibility of an unpleasant outcome for you, and the losers—those customers, perhaps financially excluded, who might have found an innovative product useful to them—don’t even know what they’ve lost, let alone know who to blame.

If we are to expect policy makers to facilitate innovation that can lead to financial inclusion, then these incentives have to change. As in any other domain, we must accept that with experimentation will come some risk, and that the proper role of financial authorities is to manage that risk—not to eliminate it entirely by stamping out innovation.