This is our first in a series of responses to the provocative post last week from Ignacio Mas. Ignacio asks why the “current innovation frenzy in digital financial services in the U.S.” does not translate into action in BoP markets across the world, and puts forth a number of hypotheses.

“There are three things none of these digital players want to deal with – and never will. They do not want to get a banking license that embroils them in onerous regulation. They do not want to conduct primary identity checks on their customers (Know Your Customer, or KYC), which require physical customer contact. And they do not want to touch their customers’ cash.”

What follows is a response from Tahira Dosani and Vikas Raj of Accion’s Venture Lab, which invests in new fintech start-ups.

While it is true that much of the current innovation in digital financial services has been focused on higher-end consumer segments and less on financial inclusion, in our view this has not been a result only of digital players’ intentions. In fact, mainstream digital financial service companies’ difficulties in serving the financially excluded arise primarily from three key factors – cost, connectivity, and capability. Simply put, these customers are more expensive to acquire, harder to access, and require targeted products, pricing, and distribution. Customers that are banked, connected, and well-understood are the low-hanging fruit today, and that is why they are targeted by large players.

Nevertheless, start-up companies, like those in which Accion Venture Lab invests, are able to target the unbanked and provide models for larger companies by working nimbly and taking advantage of cheaper and more accessible emerging technologies. Their niche and specialized focus on underserved segments enables them to effectively serve those customers in a way that large incumbents cannot.

1. Cost. The primary reason that the financially excluded aren’t a high-priority customer segment for fintech corporates today is that they are expensive to acquire. Getting to the economically active poor often requires expensive on-the-ground networks, financial education, and specialized staff. Moreover, transaction volumes for the underserved (and thus the revenues they generate) are smaller, at least to start. It requires very high volume for transaction-based revenue models to cover costs. Accordingly, unit economics of serving lower-income consumers in emerging markets tend to be less attractive until real scale is achieved. With that challenge in mind, we at Venture Lab are looking closely at new businesses that lower the cost of customer acquisition by leveraging existing non-financial networks such as retail supply chains.

2. Connectivity. A key driver of high acquisition costs is that financially excluded customers aren’t well connected. Cell phone penetration in developing markets is of course increasing daily, but due to often limited connectivity and still-developing data access, it remains hard to acquire these customers and serve them online, which might otherwise be the cheapest distribution channel. Moreover, the fact that these customers are unbanked means by definition that they are unconnected from financial institutions, making it harder for service providers to piggyback on existing offerings or data. The best financial inclusion startups make financial services accessible despite limited connectivity.

3. Capability. Serving low-income and underserved consumers requires a clear understanding of their needs and behaviors. The unbanked are often thought of as lacking the willingness or ability to pay for financial products and services. We fundamentally believe this is incorrect. However, reaching these customers requires bespoke product development, pricing, and distribution. Many of our investee companies focus on providing products that are specifically relevant to the underserved, and hopefully will provide a model for larger existing players.

Take Umati Capital, for instance, a Kenya-based bank lender (and Venture Lab portfolio company) focused on providing credit to small and medium enterprises (SMEs) and their corporate trading partners. Umati has found a unique model for counteracting the challenges of cost, connectivity, and capability that plague larger digital financial service players. By partnering with large corporate trading partners that buy from many smaller-scale SMEs, Umati can extend credit en masse to the small businesses with facilitation from the corporate partner and in that way ultimately lower the cost of acquisition. Umati also leverages existing mobile payments infrastructure to provide branchless financial services to borrowers and buyers, and it provides invoice-based loans – a product these businesses actually need.

Entities like Umati provide a model for larger players to engage in markets where cost, connectivity, and capability currently inhibit activity. Ultimately, large players’ disregard for the financially excluded will not be solved by an easier licensing process or less rigorous KYC or AML standards, but instead will be achieved through better solutions around the three “C’s.”

Have you read?

The Great Competition and Innovation Deficit

Fueling the Economic Engine: Global Experiments in Small Enterprise Lending

Jipange KuSave, M-Shwari, and the Influence of Start-Ups