This is our second response to the provocative post two weeks ago 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.

“In other words, why is there such an inherent innovation deficit within the very commercial ventures that we think are going to drive financial inclusion forward? Do market players really need this very granular level of handholding to get what academics, NGOs, and donors so clearly believe in? …Or is the problem, rather, that there isn´t enough of a competitive push to drive them to want to innovate as a key source of market advantage?”

What follows is a response from Gerhard Coetzee, who leads the CGAP Customers at the Centre Team.

In considering the question posed by Ignacio Mas, I am reminded of the work of business strategist C.C. Markides. He did not see it as “the great competition and innovation deficit” question, but rather, the challenge of how large institutions make two business models exist in the same organization. In fact, the question is how to serve two distinct market segments in the same institution. He notes that the large industry players that develop new radical business models are exceptions rather than the rule. Most innovations and market changing models are introduced by newcomers to that industry.

Why don’t we see the large financial service providers (FSPs), who have the ability to change things at scale, jump into this area of the market and deliver solutions to low-income and poor customers even where regulation may enable them to engage? In essence the argument focuses on product centricity, incomplete business cases, an over-emphasis on the supplier view of cost to serve, short-termism of incentive structures, and competition for resources in large organizations.

Product centricity. Large established players focus on products for customers they know. Most retail banks are focused on the middle class and the affluent, and their operations are focused on delivering products to customer segments where they are used to making money. Their revenue-enhancing activities focus on cross-selling products to the same customers, or product enhancements focused on the same customers—in essence, they use sales-driven approaches. In fact, most innovations are focused on the next big product, and the result is a plethora of products, with little differentiation (a phenomenon that Ignacio Mas calls “productitis”), creating confusion not only in the minds of customers, but quite often among the frontline staff that must sell these products.

The fallacy of the one-sided business case. Let us assume there is a notion (driven by competition, business opportunity, or political pressure) to expand our focus to the lower-income segment. The reality of a lot of small transactions and a high cost per transaction motivates providers to move away from brick and mortar as costly service points. As demonstrated by so many great examples of branchless banking, technology can drive down the costs of delivery, but what about the revenue side? Unless people use these services and accounts, there is no impact on the revenue side. Unless we offer customer-centric solutions—a customer experience that culminates in value to the customer—we will not see customers using their accounts and concomitant revenue results that will drive a good business case. Large banks have been burnt many times by opening accounts that are not used, a costly exercise that you do not want to happen on your watch as a senior manager.

Although FSPs, and especially banks, focus on the cost to serve the customer as it relates to specific channels, a more customer-centric view about cost is to ask: What costs do consumers incur when they are served by FSPs? Consider customers’ direct financial costs of getting to a point of service: opportunity costs of travel time and time away from important income-generation activities. Then add the regulatory and compliance costs of the mere act of proving who I am, and where I live, in a world lacking national identity systems and using address protocols linked to property rights. Now add the dearth of gender, age, and religion-specific solutions that heap social and cultural costs on customers. The psychological costs of the stress of debt and fear of the foreign world of banks complete the picture. We ask ourselves, why don’t customers use all the new innovations (except in a few great cases)? Well, larger financial institutions, which are not really focusing on customers, but on products, do not deliver a customer experience that entices customers into a good relationship with banks where they trust the provider. In fact, not using these products is a rational customer choice due to the high cost customers incur to be served.

Customer-centricity is a long-term investment. It means that you need senior role players with tenacity and the ability to convince stakeholders—ranging from employees, to middle management, and shareholders—that they should invest in something that will have long-term pay-off. Even though research shows that the long-term pay-off is much higher than that of some alternative models, most managers do not have the appetite to give up next year’s bonus and salary increments for something that will pay off only on their successor’s watch.

Internal competition. Another often-ignored challenge is the competition for resources that normally plays out in large established providers as internal lobbying processes that are decided by specific prioritization committees. The committee members are mostly from the finance and resource departments, in organizations that are still focused on products rather than customers. For a new idea to survive these filters, it needs to be big, well-positioned, and serve the decision makers. It should not pull too many resources away from the conventional profit areas. Consider a very small investment in a customer-centric innovation that competes with a large investment needed to serve the bread-and-butter platform of a bank. Many customer-centric innovations never see the light of day on the other side of these committees.

How do we turn all of this around in large going concerns? This is not an easy challenge to address, as leaders in large banks are facing tremendous challenges. Although most agree that there is a need to focus on customers, and understand that the long-term answer is to embed customer-centricity into these large organizations, it is a formidable task. A major component to addressing this issue is to understand the organization using thorough analysis: identifying where the biggest challenges reside and addressing these with a comprehensive strategy, implemented incrementally. This means that you need to identify which levers will have the biggest impact, and start working on those first. It could be having a committed leadership, with a longer term goal, or creating an insights unit that feeds essential customer information into the organization for the design, delivery, and maintenance of a positive customer experience. Solutions will differ due to contextual variety. The essence is that long-term survival and value to all the stakeholders (customers, employees, and investors) in large established organizations, such as big banks, lies in customer-centricity as a business model.

Have you read?

The Great Competition and Innovation Deficit

Accion Venture Lab Responds to ‘The Great Competition and Innovation Deficit’

Does Financial Inclusion Need to Be More Customer-Centric?

In our first post in this series, we described the need for an approach to financial education that was both effective and scalable, and we offered embedded education as a potential solution. Our second and third posts described how the embedded education approach works and showed its potential effectiveness by describing the improved money management behavior displayed by clients in Zambia after participating in our program. We believe that these findings also revealed the potential for a business case for delivering financial education using the embedded approach.

For a business case to exist, two things have to be true: financial service providers (FSPs) need to see a positive, bottom-line impact from an embedded program and a financing mechanism needs to exist that can compete with the current grant-based model for funding financial education.

Bottom-Line Impact

Financial education can positively impact financial service providers in a number of ways (aside from knowing that they’re empowering individuals to take control of their financial lives). Offering training could improve client retention by strengthening loyalty. It could reduce customer service requests by increasing familiarity with a banking process. But our market research suggests that the biggest potential impact is lowering write-off ratios and increasing savings balances.

Using data from The MIX, we estimated that in 2012 alone, loan distributing MFIs wrote off $1.4 billion from their portfolios. And that number underestimates the total value of write-offs by a considerable margin because it only includes the almost 650 MFIs that had reported enough data for these calculations. In The MIX database alone, there were an additional 600 MFIs that did not report the data necessary to estimate losses resulting from write-offs. The sums are not insignificant at the individual MFI level either. Of the 650 MFIs for which enough data was available to formulate estimates, roughly 20 percent wrote off more than $1 million. In the largest MFIs, reducing the write-off ratio by a fraction of a percentage point could result in millions of dollars of savings in a single year. Even small to medium sized MFIs could realize hundreds of thousands of dollars in savings. Using MFO’s portfolio-at-risk results from Zambia and our cost structure as a base, we believe that many MFIs could easily afford to pay for the implementation of an embedded education program from the savings such a program could generate.

Competing with Grant Funding

A current challenge, though, is grant funding. Why would an MFI pay for an embedded education program when grant funding may be available for more traditional models instead? The answer is that grant funded programs are unlikely to be able to close the financial capability gap in the long term because they are not realistically scalable. If educational trainings are not incorporated within existing service touch points, the MFIs are forced to develop or alter portions of their organization to create a space to educate clients. Estimates of the cost of closing the gap with current educational methods already stands in the billions of dollars and the needs of clients will only increase as FSPs continue to create innovative products and push services to the bottom of the pyramid.

There is an alternative that can compete with the low-risk nature of grant funding for FSPs: offer embedded education on a pay-for-performance basis. In this model, organizations like MFO design an embedded education program for an FSP and cover the costs of designing and implementing this program in return for payments if the program meets agreed-upon performance benchmarks that the FSP values, such as decreased default rates. For example, an FSP might hire a firm that develops financial education programs to design and implement a debt management education program to decrease delinquencies and defaults. In return for this work, the FSP shares with the developer the savings it realizes from decreased delinquency and its associated costs. The FSP also enjoys the added benefits that come with more capable clients.

This approach could have significant benefits for those working to promote financial inclusion. It ensures that education programs are problem-focused – an FSP will only select an education program if it addresses a particular problem it has, and an education provider will only choose projects that generate value for which the FSP is willing to pay. The approach also ensures that a successful program will last because the FSP will have a tailored education program embedded into their operations from which they will continuously derive tangible financial benefits. For non-profits and small private organizations whose mission is to deliver high quality financial education programs, the pay-for-performance model has the potential to create a sustainable revenue stream, which will also be necessary for financial education programming to reach scale. For grant makers, this approach provides an avenue to a self-sustaining, scalable solution to addressing the financial capability gap. It weans both implementers and FSPs off grant funding for these types of projects, freeing up valuable resources for other initiatives.

The Path Ahead

Successfully implementing a pay-for-performance project is by no means easy. Issues of contracting and close monitoring take on greater precedence while the fact remains that this approach has been untried, as far as we know, in the financial inclusion space. Despite these challenges, we believe the pay-for-performance model offers a clear path toward delivering financial education on a sustainable basis at scale. Through our work, we have found no other alternative that can claim the same.

MFO has already begun to discuss implementing this model with investors, donors, and financial service providers. With the ultimate goal of expanding access to financial education, we welcome those in the financial inclusion and financial capability development fields to question and comment on this approach as we continue our work on closing the financial capability gap.

Guy is Executive Director of Microfinance Opportunities (MFO). Before becoming Executive Director, Guy was a Senior Advisor to MFO and served as Principal Investigator on five Financial Diaries studies and as project leader for the development of the Financial Capabilities Index Web Portal. Guy received his Ph.D. from the University of Chicago in 1994, and subsequently worked for four years in Chicago in the field of community economic development. He then served 13 years as a Lecturer in Public Policy at the Harvard Kennedy School where he taught courses in management and microfinance. He continues to teach in Executive Education programs at the school.

As Microfinance Opportunities’ Research Officer, Eric manages consumer research projects and performs quantitative analysis for both the consumer research and financial education teams. His work focuses on understanding how low-income households manage their cash flows and their implications for financial inclusion. He is currently working on projects in Ghana, Tanzania, Myanmar, and Zambia. Eric holds a Master in Public Administration with a focus on International Development and Administration from the Maxwell School at Syracuse University and a Bachelor of Arts degree in economics and political science from the University of Nevada, Reno. Prior to joining MFO, Eric was a member of Teach For America in Denver, CO where he taught high school mathematics.

Have you read?

Embedded Education: Taking Financial Education to Scale

Design and Implementation of Successful Embedded Education

Evidence Favoring the Embedded Education Approach from Zambia

The Financial Inclusion 2020 campaign at the Center for Financial Inclusion at Accion is building a movement toward full financial inclusion by 2020. This blog series spotlights financial inclusion efforts around the globe, shares insights from the FI2020 consultative process and highlights findings from “Mapping the Invisible Market.”

Both client value and a business case are needed for microinsurance to be sustainable. In an ideal world, the two ultimately reinforce one another. Value is recognized by clients, leading to greater satisfaction with and demand for insurance, while demand leads to reasonable profits for insurers, enhancing their ability to provide value to clients in the medium and long-term.

In an effort to better understand how profitability and client value complement one another and how they conflict, the MicroInsurance Centre’s Microinsurance Learning and Knowledge (MILK) project conducted extensive research on health microinsurance in Kenya.

Understanding client value and the business case

To understand client value, MILK conducted two “Client Math” studies. These quantitative assessments seek to understand the value of insurance compared to other risk management tools by exploring the differences in how insured and uninsured households cope with financial shocks. We looked at hospitalization insurance products offered by two private insurers: the Afya Yetu Initiative, an NGO that oversees and implements 30 Community-Based Health Insurance schemes, and the commercial insurer British-American Insurance Company Kenya (Britam). We surveyed low-income people (insured and uninsured), asking them about the direct, indirect, and opportunity costs they incurred in connection with a high-cost hospitalization as well as the strategies they used to finance those costs.

Overview of products studied

We found that while both products provided value for clients, the Afya Yetu product offered more generous coverage. Post-claim, Afya Yetu policyholders paid only a quarter of the total costs of hospitalization of their uninsured counterparts. By contrast, Britam’s clients paid 80 percent as much as their uninsured counterparts. In both cases, insured respondents were able to finance their costs more independently than uninsured respondents by reducing spending in the short-term rather than taking out loans. The Afya Yetu product is simpler and was thus better understood by respondents than Britam’s more complex product, which offers eight different levels of coverage. Afya Yetu uses a relatively “high touch” enrollment process that leverages existing relationships with agents from within the communities of the target populations, thereby educating clients and building trust. Britam’s clients, by contrast, struggled to understand their coverage; of the insured respondents in our study, 60 percent reported paying more than they expected to pay for their hospitalization.

To understand the business case, MILK analyzed financial outcome data for Afya Yetu and Britam over the 5-year period 2008-2012 and held detailed interviews with management of these insurers and other key stakeholders. Neither has achieved sustained profits on its microinsurance activity, but both programs have taken steps toward sustainability. Britam’s business case is the most promising, at least in the short-term, as its claims ratios have trended down in the last two years and it reached profitability in 2012. While not a major player in the health space in Kenya, Britam does have significant traditional health insurance business to support its HMI schemes. MILK found in other studies that insurers with mixed books of business can support a micro segment more readily than standalone microinsurance schemes, at least from an expense structure point of view. While Afya Yetu does not have that advantage, it does have a resource-sharing model that allows smaller community based groups to achieve some economies of scale.

Tensions and trade-offs between client value and business case

Combining our findings, we see clear tensions between client value and business case, but a balance remains possible. Afya Yetu provides high financial value for those who make claims, and understanding and familiarity with the product seem to lead to frequent use by clients. Afya Yetu may be something of a victim of its own success: as members become better educated about the product and more accustomed to accessing coverage, claims have increased, calling the program’s financial sustainability into question. Afya Yetu had apparently been forgiving in premium collection and generous in benefit payments and was forced to raise premiums to catch up with costs of providing value. In contrast Britam started with modest medical benefits and then increased them to stimulate demand, but has struggled to communicate the relatively complex product details effectively to its low-income clients.

We are optimistic that client value and business case can be balanced. As Britam, Afya Yetu, and other insurers work to do so, they may benefit from considering some of the critical features of the programs we studied that contribute to and/or undermine the client value proposition and the business case:

• Level of coverage. Increasing the level of coverage may not always be the best way to improve value, especially in a market such as microinsurance in Kenya, where insurers struggle with high claims ratios. Other product features, such as simplicity and ease of use, are also critical determinants of the value clients receive.
• Simplicity and flexibility. Simplicity can serve both clients’ and insurers’ interests, even if this means sacrificing some flexibility or choice. Britam’s product offers clients more flexibility in terms of both coverage and service providers, but the simplicity of Afya Yetu’s product might be more valuable, as clients better understand and can effectively use the product.
• Perceptions of value. Clients’ perceptions are related to product coverage, but also to features such as simplicity and ease of use. These perceptions are important to understand, particularly for voluntary programs, as they drive demand, enrollment, and renewals. Small changes can often be made to increase value with little cost implication.

To clients, a business case matters, as it influences long-term program viability. To insurers, client perceptions and experiences matter, as they ultimately drive the demand for their products. If we are to provide clients with valuable products over the long-term, this strong interconnectedness and the tensions that often arise between value and business case will warrant careful consideration and further investigation.

The full study was written by Richard Koven, Barbara Magnoni, Emily Zimmerman, Danielle Sobol, and Laura Budzyna, and can be found on the MILK Project website.

For more information on Financial Inclusion 2020, sign up for campaign updates.

Richard Koven is Business Case Manager for the MILK Project and a MicroInsurance Centre Consultant. He has 30 years of experience managing and consulting with insurance companies, health plans and self-funded programs, including ten years with emerging microinsurance programs.

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