> Posted by Nate Gonzalez, Investment Officer, Accion Venture Lab

The following post was originally published on Next Billion.

In this age of “big data,” technology has begun to drive strategy formation, and this shift could have big implications for traditional businesses and social enterprises alike. In a thoughtful and engaging presentation (below), Philip Evans, managing director and partner at Boston Consulting Group, explains why. Most traditional businesses, he says, operate in a value chain, where transaction costs are the “glue” that holds the chain together. Large corporations (such as banks) have been able to fend off competition by sufficiently reducing transaction costs through economies of scale. However, as the accessibility and flow of information has become cheaper and faster, the transaction costs traditionally associated with accessing the information needed to make key business decisions (e.g., extending a loan) have plummeted.

Plummeting transaction costs create space for new entrants to come in and completely disrupt traditional value chains and corporate structures. In his presentation, Evans lays out the case that lies at the foundation of the investment thesis behind Accion Venture Lab (where I am an investment officer): Start-ups with technology-enabled models can create scaled products and innovate much faster, smarter, and more cheaply than incumbent institutions.

Here in Nairobi, this is particularly relevant to the small- and medium-enterprise (SME) lending space. Most banks in East Africa view small businesses through a horizontal lens, the prevailing wisdom being, “All SMEs are relatively the same in terms of their risk profile, and thus we need two years of audited financials and 100-125 percent collateral backed by hard assets to issue a loan.” The result is that very few SMEs qualify for funding in this market. Based on data from a McKinsey report on the credit gap for SMEs in sub-Saharan Africa, we estimate that there is a USD $2–5 billion unmet credit need amongst these businesses in East Africa alone.

Microfinance institutions (MFIs) have long sought to address this issue, but it’s well documented that the transaction costs for determining the true risk profile of a small or micro-business (e.g. through group lending models or loan officer visits) are very high. So, you have one group of debt providers (banks) that feels the opportunity costs of more tailored risk assessments for SMEs are too high, and another group (MFIs) that’s willing to lend to this segment on principle, but the high transaction costs associated with their operations and risk-mitigation techniques too often prevent these institutions from scaling.

However, as new pools of alternative data have been made accessible, we’ve seen a number of start-up, non-bank financial institutions (NBFCs) come online, and they could be poised to disrupt the status quo of East Africa’s lending industry.

To read the rest of this post, visit Next Billion.

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