The Three Billion New Middle Class Opportunity

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The Successes & Technical Challenges of Mobile Financial Services in the Emerging Markets

In April 2007 a single drip-like event occurred.  Slowly, slowly, that first drip was joined by more drops. Those drops eventually created a rivulet. That rivulet was joined by yet more volume and a stream was created. Now growing more quickly, the stream leaped from torrent to raging river in no time. Until finally it was itself a part of an ocean and a tsunami unrecognizable from that first initial drop.
That drop in April 2007 was the first payment initiated from one mobile phone to another in the system called M-Pesa run by the leading Kenyan mobile operator, Safaricom. From that humble origin just over seven years ago, M-Pesa now:
•    Serves approximately 82% of the adult population or 19.3M people who have opened an account
•    Transmits >43% of Kenyan GDP each year
•    Processes 101.3B Kshs ($1.3B) in transaction value per month
•    Contributed 19% (26.6B Kshs, $304M) of Safaricom revenues in last financial year
M-Pesa is now the idolized example of what is possible when the mobile phone is combined with a simple form of banking and payments. Around the world, hundreds of organizations have attempted to replicate M-Pesa’s success with varying outcomes. In this paper, the opportunities, challenges and potential winners or losers in the quest to merge the mobile phone and emerging markets financial services will be examined.
3 billion new middle-class by 2030
In the coming decades, the emerging markets will be transformed by a fundamental increase in wealth. The Brookings Institute estimates that three billion people will make the transition to the middle class, the vast majority of which are in the emerging markets.
Today, 1.8 billion people in the world are middle class, or 28 percent of the global population. About half of these people live in developed economies, with another fifth found in Brazil, Russia, India, and China – the so-called emerging BRIC economies. Less than 2 percent of the world’s population is rich by our definition; a significant majority, 70 percent, is poor. Our scenario shows that over the coming twenty years the world evolves from being mostly poor to mostly middle class. 2022 marks the first year more people in the world are middle class than poor. By 2030, 5 billion people – nearly two thirds of global population – could be middle class.
The timing may vary as economic hiccups may push this growth further out or bring it even sooner, but the outcome remains an enormous increase in wealth, primarily in the emerging markets.

Will new wealth stay in a tin can?
While three billion new middle class will be created in the next decades, the current access to financial services is limited. According to the World Bank, in 2011, only 50% of the world’s adults had access to a formal financial institution. This drops precipitously in the emerging markets with only 24% of developing Sub-Saharan Africa and 18% of developing Middle East & North Africa having access. China is above average at 64%, while India lags at 35%.  When compared to the middle class growth figures, it is clear that financial inclusion levels must increase dramatically to support the growth of the middle class.

The implication is that 50% of the world’s population is keeping what little spare cash they have in informal locations or alternative assets. Whether in a can, a box, under bedding or in goods of unstable value such as gold jewelry or livestock, these solutions are not going to be effective as wealth grows. Already today these solutions deprive the owners of safety, security and value stability.
Banking must grow to meet the need. For many, traditional approaches have been the norm. Bank branch penetration becomes the definition of reach. However, branches may cost a half-million USD or more, take months if not years to build and have high operating cost. For example, if India were to increase its inclusion rate from 35% to 70% using bank branches alone, it would have to grow the number of branches from the 82,000 that existed in 2009  to 164,000 by 2030 –  to achieve this, it would require opening 18 new branches per business day, every day for 21 years. Considered another way, the US has 35.7 branches per 100,000 inhabitants and 88% of those over age 15 have an account with a formal financial institution. India has only 11 branches per 100,000. By such a measure, India would need more than 240,000 branches to compare.
However, a new solution emerged fifteen years ago, bringing together the increasingly ubiquitous mobile phone and simple banking-like services.
The birth of mobile financial services
One of the first examples of mobile money was in the Philippines when Smart Telecom and Banco de Oro worked together to create a service in 2001 . But it was not until Safaricom in Kenya (jointly owned by Vodafone and the Kenyan government) would launch M-Pesa in April 2007 that the world would begin to appreciate the potential of combining the mobile phone and financial access.
Safaricom included two critical building blocks in M-Pesa: access to almost every mobile phone in Kenya and a large number of small merchants to act as agents. When M-Pesa was launched, Safaricom had 70%  market share of mobile subscribers. With such a high share, matched in few countries worldwide other than China (China Mobile) and Mexico (Telcel/America Movil), M-Pesa users could have a strong degree of confidence that others in Kenya would participate or be reachable. In essence, M-Pesa could promise critical mass and therefore achieved network effects in M-Pesa with great speed. As will be discussed subsequently, this factor alone has been a major obstacle to other mobile financial services approaches, including M-Pesa examples outside Kenya.
Also important was a strong agent network. Agents form the primary physical interface for users of M-Pesa. Much like a bank branch, agents support the process of sign-up and know-your-customer (KYC) documentation and go on to act like human or retail ATMs providing cash-in and cash-out services. Today M-Pesa functions through some 81,025  agents spread throughout Kenya.
The key M-Pesa service elements:
•    Closed-loop, with Safaricom as only issuer
•    Multiple acceptance points: primarily agents and online merchants, but increasingly physical merchants as well
•    Prepaid funds only: consumers exchange cash for M-Pesa balance
•    Primary transaction types: airtime top-up, domestic remittance, billpay
•    Cash-like transactions
While the consumer touch-points of mobile phone and informal-agents is novel, it is important to appreciate that the fundamentals of banking and payments remain. Safaricom maintains an account ledger, is required to comply with know-your-customer (KYC) and anti-money laundering (AML) regulations, funds are held by regulated commercial banks and liquidity in the system is managed much like a traditional bank.
As described in the introduction, seven years later, the outcome has been staggering with over 43% of GDP following through the system annually.
In contrast to M-Pesa’s mobile operator led success, to date, there have been few bank-led successes. A major factor in this dichotomy is simply the ability to securely reach the mobile phone. One of the examples of initial success for a bank-led model was Nokia Money in India. In 2008, Nokia began investing in the potential of mobile financial services in the emerging markets (full disclosure: an effort I participated in). In partnership with two foresighted Indian banks, Yes Bank and Union Bank of India (UBI), and no mobile operators, Nokia Money rapidly scaled to 1.2 million users and over 10,000 agents, a pace matched only by M-Pesa Kenya in the history of mobile money. In contrast to its naming, Nokia Money was surprisingly available to all types of mobile phones and all mobile operator customers, precisely in order to maximize network effects. Unfortunately, the ultimate potential of Nokia Money’s bank-led model was not to be determined. With the success of Android and Apple, Nokia’s profit pools were decimated and, in spite of Nokia Money’s early success, Nokia Money could not prevent the mobile giant’s fall. But what Nokia had shown is the potential for a bank-led model to succeed, with the right technology enablers in place.
Beyond M-Pesa and Nokia Money, many other success stories are emerging, but like any network effect business, it is sometimes difficult to distinguish the winners from losers in the early years. As the below chart from GSMA indicates, while some businesses spike within months of launch, others can take over three years to hit their stride. In Sub-Saharan Africa there are 98 million registered accounts, double the number of Facebook accounts with 203 million worldwide as of June 2013


Figure 3: Claire Pénicaud & Arunjay Katakam, “State of the Industry 2013: Mobile Financial Services For the Unbanked”, GSMA
The challenge and necessity of reaching users with mobile financial services

Traditional financial services providers, such as retail banks, have recognized the enormous potential to expand the reach of financial services in the emerging markets via the mobile phone. Twenty years ago, telephone services were a luxury product for a wealthy few via fixed landlines. Since then, the mobile phone has democratized access to communication for all. The mobile phone has reduced the cost and complexity of communication to be a non-issue for the majority. Financial service providers have recognized that the mobile phone can have an equal if not greater impact by dramatically expanding the reach of their financial services. However, there are hurdles to overcome in achieving this goal: access to potential users, technology limitations, security concerns, education hurdles, and so on.

The goal is simple, to reach the maximum number of potential users in your market. Reach brings critical mass which generates network effects and results in scale efficient offerings. This is especially true for mobile payments oriented services. In the developed markets today, electronic payments are defined by Visa and MasterCard. Their far broader acceptance network (reach) makes them the default electronic payment option. Other options exist, but are fundamental niche in their focus. In the emerging markets, there is a race to define the next default acceptance network; in Kenya, it is M-Pesa.

The options to reach users with mobile financial services

The race to reach all mobile phones becomes the critical objective of the mobile financial services provider. While mobile telecom operators can reach their own customers effectively (as M-Pesa has done), in most markets, any single mobile operator rarely has more than 30% market share, insufficient to create a truly default payment option. Meanwhile, non-mobile telecoms are limited in their options to reach users. The below decision tree describes the options to address these challenges.

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