Payments and Expanding the Global Economy

27 December 2012

With the end of year approaching, I was a bit reflective this weekend. What problems in the World really matter? Poverty alleviation, the global economy, war, …etc.

Readers need not worry that today’s blog will take the form of a Dyadic Peace exposition, however as Christian and Capitalist I fundamentally believe in the tie between Democracy, Capitalism and Freedom (a fantastic book). A concept which seems obvious and in no need of defense… However I’ve recently been challenged to defend capitalism particularly as it relates to the poor and less fortunate. Quite frankly capitalism takes time to defend and explain… it’s not at all obvious how market forces benefit all of society.

Capitalism holds money and people accountable. Therein lie many issues, for example: what do you do with people and businesses that don’t perform? Entities which serve a “good cause”? What functions should be assumed by the government, corporations, individuals? When should choice be allowed? When are market incentives “broken”? Who decides what is “broken” and what other controls are there to “correct”? (see Milton Friedman’s book above for detailed discussion).

Modern democracies assume control of many functions and services (ie banking, health care, transit, home lending, …), but how will these services take place in markets with dysfunctional economies and governments? What is the precedence: Government? Markets? or Freedom?

My belief is that information is the first critical step toward democracy, freedom and an effective market based economy. Informed individuals can make efficient choices both in goods and services, as well in their government. Given that most individuals will act in their own self-interest, information ensures markets operate efficiently at a macro level. The same should be said of Democratic Governments which should operate with necessary checks/balances but, regardless of their efficacy, will be held accountable both by individuals with information, and external markets (aka Greece, Italy, and the US). As we have seen, the accountability of governments to both individuals and markets is usually not aligned…  elected politicians are seldom incented to make rational market decisions. Yet I digress..

Information and Emerging Markets

The global economy is at the cusp of something truly transformational: empowering individuals with both information AND basic financial services. Most of this transformation has happened in the first world, for example 64% of the global GDP is created by US, EU and Japan (13% of population), but emerging markets are a far different creature (economically and politically).  My belief is that mobile phones are the key network and “enabler” to deliver: connectivity, information, infrastructure (ex payments/financial services). Connecting individuals will enable market forces which will effect both governments and economies. The best model of success is Brazil, the most successful democratic BRIC which also has the fastest growing and most profitable payments environment in the world.

Efficient Markets, Financial Services, and Payments all share network dynamics. Just as a commodity market helps the farmer expand price awareness beyond a local buyer, a banking market allows for competition in saving and lending. It is difficult to underestimate how poorly formed emerging market networks are. For example, 92% of all electronic transactions are completed within the world’s top 10 markets. There is a density and n2 (“n squared”) effect in networks and their efficiency. The exception to network success in emerging markets is mobile: 5.3B mobile users (77% of the global population). How can we leverage this mobile network to transform economies (see MPesa’s impact on Kenya)?

Although this transformational “summit” is in reach, there are many obstacles ahead, some of our own making. For example, information and “connectivity” are tremendous threats to governments and entities that are in control, and uncompetitive, today (example is the recent ITC efforts to “govern” the internet). Banks also tend to view telecom networks as a threat and most work actively to block expansion of their “payment” capability.  Other examples include efforts by well meaning NGOs and philanthropists to kick start financial services (as I outlined in my Blog from Dubai last year). Entrepreneurs and investors have learned important lessons in the last 5 yrs, one of which is nothing is sustainable unless market forces can operate (ie. stay away from highly regulated markets with artificial incentives and NGO money).

Payments and Financial Services

Why do I care about payments and financial services? It is the “phase 2” of a functional market; the lifeblood of commerce and competitive markets. Recent emerging market successes: Brazil, Kenya, Philippines, Columbia, Peru and Pakistan. There is no one single ingredient for success, if there were every country would follow. It seems to entail many common elements, among them: consumer protection, consumer information, capable service provider, stable economic environment, supportive banking regulator, consumer marketing, sustainable pricing/margins, merchant participation, cash in/out, …

Like Brazil, functional markets which begin this phase 2 will see tremendous investment in services that surround basic financial network, thereby evolving it to maturity. Governments will benefit from commerce transparency and moving black/grey markets to taxable ones. Consumers will benefit as service providers unleash basic lending (individual) and investment (commercial) in emerging markets. Our common purpose is to spur the global economy and lift billions out of poverty.

For example, while I ran Channels for Citi a key constraint for growth (Card and Direct Banks) was the availability of real time (positive) credit bureaus. It was very difficult to open accounts outside of the branch, or to loan money. What if consumers could build a reputation separate from their bank? I have a reputation on Facebook, eBay and Amazon. Of course this reputation is different from the one of I have at my bank, but could it be of benefit to basic financial services? These questions are emblematic of what is possible once we “connect” consumers to a network and the network evolves from supporting information to commerce.  account opening sighting

Of course I’m not the only one to see this. I’m very fortunate to know leaders much more skilled than I am in this area: Nick Hughes (MPesa creator), Amy Klement (Omidyar Network), Chris Brookfield (Elevar Equity), Sriram Jaganathan (CEO Bharti mFinance), Abrar Mir (UBL Pakistan), Monica Brand (Frontier/Accion), Nvalaye Kourouma (CEO AfricExpress),  … Why hasn’t more been achieved? In my view it goes back to Capitalism and market forces. There is a conflict in approach to providing basic financial services. A conflict which much be discussed as it is impeding progress, or worse destroying sustainable initiatives.  My strong belief is that success requires sustainability, and a profitable business is by definition sustainable.  It’s fair to say that “profit” is an offensive word to many people in emerging marketsYet our goal must be to enable markets and market driven services… there is no other option.

Investment Conflict

While there are many great people (with very noble objectives) operating at the base of the pyramid; there are few capitalists and business executives. It is very tough to build a business that serves the poor, margins are very tight and success therefore means building volume. When volume is important, existing networks with distribution are a key consideration (see previous blog MNOs rule in Emerging Markets). The areas where we do see great executives, and expert emerging market investors (ex Accion, Omidyar, Elevar, …etc.), their efforts are frequently impaired by money that seeks no return (Aid groups, NGOs, and Philanthropies).

Although grant money does wonderful things for areas that do not infringe on markets (ex. Pre-natal vitamins, clean water, …), the money can completely destroy competitive markets through the creation of unsustainable organizations. For example, if Pakistan had 5 companies competing in payments and only 2 of them received $10M Gates Foundation grants, guess what happens to the 3 that did not receive money? They are priced out of the market.

Money that seeks no return (Grant, Government, …) in commercial activities not only influences sustainability, it also influences the “orbit” and strategy of everyone in the ecosystem: regulators, banks, press, talent, …etc. Support entities develop in this fertile  “free money” environment that are geared toward attracting grants, running the programs. For example, a consulting group operated as program manager to Gate’s UBL investment.. their expenses represented 30% of the total grant (I promptly left the formal advisory group)! Fortunately the UBL team is top notch and knew better than to pursue grant goals of financial inclusion over economic goals of sustainability.

For Capitalists and Investors the dynamics above translate into volatility. Volatility always exists when there is a high degree of uncertainty and money is not held accountable for performance. Commercial areas that attract NGO money are hit hardest (ex. Payments and financial services). Thus the very markets where I most want to help are harder to invest in. For example, our companies could do everything right.. and still fail because of external (non market) forces.  Investors in this area could all tell 100s of stories about India particularly a country ripe with opportunity yet rife “entrenched interests” (to say it kindly).

Our common cause

The intermediate “flux” period in market creation is painful. There are many entrenched interests that want to keep competition at bay. However we all must agree on basic tenants when operating within existing markets, or we will continue to waste valuable time, capital and people. Investors in emerging markets must find ways to coordinate and discuss conflict more effectively. We must encourage governments to create policies and regulations which enable effective information flow, networks, and markets. As Brazil demonstrates, it’s much better to have a slice of a very big pie.. than control a share of a very small one.

Our objective is not to spread the global GDP around more evenly, nor are we talking about global labor arbitrage. Our objective is to grow the global GDP.. markets create wealth.. A premise which needs well informed defenders and advocates. We should not be ashamed to say we want to create profitable companies in emerging markets… this is a tremendous vocation.

Wrap up

Although Starpoint is 80% focused in OECD 20 countries, our emerging market activities are invaluable. My personal reasons for involvement are both philanthropic and aspirational. The opportunity to provide financial services for 600-800 million people over the next 6-10 years could be THE KEY event which drives global GDP growth (and hence poverty alleviation). Make no mistake the entire pyramid of consumers (affluent at top, poor at the base) will grow, but it is the base of the pyramid which will dominate the numbers.

Happy New Year

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