Reputation – Commerce Implications

9 January 2013

I’m sitting in NYC waiting on my plane..  thinking about reputation, not only explaining the importance of a “good one” to my 12 and 8 yr old boys, but also thinking about its broader importance in commerce. Where do I have reputations today?

  • Commercial: Bank, Credit Bureaus, Card Issuers, Local Merchants, Employers, Customers, Suppliers, Amazon, Linkedin, eBay, Blog, Google, …
  • Community: Friends, Neighbors, Schools, Church, Organizations,
  • Personal: Hospital, Government, Police, Government, Friends, Colleagues

Throughout history reputations were 100% dependent on relationships. These personal networks were the primary conduit of reputation information.  Financial services have benefited greatly, over the last century, from improvements made to reputation portability and standardization.

In this modern era, eBay offers many lessons in relevance of reputation, demonstrating what great things can happen when tools exist to manage it.  There are also many negative lessons here. For example in 2004, eBay launched into China. Prior to launch eBay’s risk organization wanted to keep the China community separate from the US. Community separation was a logical recommendation given that reputations take time to build, and dependent on community context. In the US buyers and sellers work for years to build trust and “confidence”. Reputations forged by self-dealing, or other fraudulent practices, were ferreted out. Unfortunately Meg didn’t want this community separation… she wanted one big community.  Within weeks Meg saw the downside of operating these 2 together, as fraud shot through the roof..  thus separating the communities and opening the doors for other competitors (See this Stanford University Case Study).

Reputation has a very strong societal and community context.  I told my sons that a Chef with a great reputation in New York or Paris means something completely different than a great Chef in a community of cannibals (… well it made them laugh). Markets hold people and money accountable, and the ability to measure and convey a commerce reputation is critical for network growth and efficacy. Banks have long held a central intermediary role in commerce as both a “reputation authority” and a manager of the corresponding risk. For example, letters of credit (LOC) are an instrument extended to a supplier receiving an order from an unknown buyer. After all, receiving an order for 100,000 widgets from a known buyer carries a far different weight that one from one that is unknown. Thus an LOC reduces the risk to the supplier by allowing money to be held by a 3rd party bank while the order if fulfilled.

Another excellent reputation example is in serving the poor at the base of the pyramid. In 1976, Muhammad Yunus created the concept which led to Grameen Bank, a success which resulted in the 2006 Nobel Peace prize (see Wikipedia). Muhammad recognized that lending must be tied to a reputation which is critical to maintain: that within the local community. The Grameen model lends money to a community group, whose individual members are mutually responsible for the loan. This is a fantastic model. What further opportunities could exist if participating individuals could expand their reputation outside of the community?

Modern markets have demonstrated that improving the portability of reputation expands the capital attracted to that market. For example financial markets expanded by specialists operating in a securitized model where risks could be aligned to capital. In retail banking, local markets evolved from local banks to national. Each bank could make rational decisions on where to participate and specialize in this market.

In business-business commerce reputation is a critical factor in the success of JIT inventory, virtual supply chains and vendor managed inventory. Few companies would be willing to let an unknown participant into their network. In the online world, eBay and Alibaba have done a tremendous job building communities around reputation. Wouldn’t it be nice if you could take your reputation with you? For example if Prosper or Zopa could get through regulatory hurdles (see here on their issues), lending could be done in an ad hoc community of investors without a banking license.  Commerce would be done based upon your community reputation (eBay/Amazon), and risk would be managed through non financial data from retailers, facebook, MNOs, …

Unfortunately few of the holders of your reputation are incented to share it (in a positive sense). Few people know that there are roughly 4 times the number of negative credit bureaus as there are positive. In other words, every bank and supplier are willing to share their negative customer information (ie didn’t pay their bill), very few are willing to share their positive customer information. In most OECD 20 countries, positive bureaus are not the result of commercial initiative, but rather a legal or regulatory one (Wikipedia Equifax).

In the US we have more of an aggregation problem.. how do we manage multiple reputations. In emerging markets the problem is much different: How do you build any kind of reputation? One of the first problems to crack is identity. How do you assign an ID that sticks? We see many government initiatives around National ID, but this takes time. Is there another number or ID that we could use in the interim? It certainly seems that a cell phone number makes the most sense given its global penetration of 5.3B consumers (75%+ of the worlds population). Could emerging market carriers enable an opt in “reputation” consumer service?

I’d love to see a few companies work toward this end.

In the US, I’d love to see a consumer service that just measures my reputation in all of these places (beyond banking).

Sorry for not finishing this blog cleanly…



Reaching the Unbanked: Thoughts from Pakistan

Mobile presents 2 primary “disruptive innovations” to the world’s second oldest profession: 1) Access/Cost to Serve and 2) Acquisition. Let me emphasize, mobile does NOT present a “silver bullet” solution to banking. Bank products must still be profitable. In emerging markets, banks have a very poor reputation at the base of the pyramid. Banks are limited in their ability to develop products which can be priced and distributed at the base of the pyramid, not just in emerging markets, but here in the US as well. Mobile banking will not solve this problem, but only allow poorly suited banking products to reach more people at a slightly lower cost. Although mobile does not significantly impact existing banking models, it may allow for the development of a “new products”, one of which is payments.

23 March 2011

(sorry for the typos in advance)

I’m up early in Dubai.. meeting with the UBL/Omni Pakistan team on their mobile money initiatives. I love visiting emerging markets to learn about successful projects. Pakistan is well on its way to becoming a leader in reaching the unbanked through mobile solutions, perhaps surpassing the Philippines, Brazil and Kenya. Beyond having a fantastic regulator, they also have 2 excellent teams:

#1 Abrar Mir of UBL/Omni and

#2 Nadeem Hussain, CEO of Tameer Bank, (ex Citi executive) Telenor/Tameer.

Make no mistake, their success to date has been 100% domestic.

In the US, we frequently get caught in a rather narrow “US centric” view of everything. Keeping a connection open to emerging markets is a great way to keep a fresh perspective and question “foundational” paradigms. New ventures in emerging markets are frequently challenged in attracting capital, even in high growth “BRIC” economies. Although many countries have worked hard to replicate the US venture model, few have succeeded. US/EU venture money normally focuses on investments which are geographically close to provide active management and reduce legal complexity (ex. control, investment, share holder rights, liability, intellectual property, …). Emerging market innovators are left with a much reduced set of options: “local” venture firms, banks, private investors and a small number of specialist US venture teams (Elevar, Omidyar, …etc).

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.

For those of you that have followed my blog, I have been tracking several Indian projects over the last 2 years. I’m so frustrated by the bureaucracy and corruption in India, that I have given up on that country. There are a number of companies (ie Bharti, Vodafone, SKS…) that could deliver, but they are stymied by a regulator that cares more about control than progress ( MNOs Rule). It’s important to understand the political dynamics of emerging markets, particularly for well meaning investors that want to take part in the growth opportunity.

The last 7 years has been a time of much experimentation. Many mobile initiatives have been spun up by MNOs, Banks, Card Networks, NGOs, MFIs, MSBs, … etc. Within the unbanked world, MPESA stands out as the “model” unbanked success. It was started in 2004 by Vodafone after receiving ~2M GBP in grants (from UK’s DFID ). I’m highly appreciative of efforts by the World Bank, CGAP, USAid, UK’s DFID, NGOs… (Aid Groups). These teams are comprised of tremendous people driven to make a difference in the world. My trip to Dubai today was my first focused interaction with the Aid/NGO community, as most of my life has been spent in the private sector.  I have several observations which may be of benefit to start ups and investors in this area.

Objectives of Mobile: NGO/WorldBank/US Aid vs Private Sector

There are not many “new” ideas in banking. It is perhaps the world’s second oldest profession. Banking in emerging markets has several challenges: laws, consumer protections, consumer identification, literacy, bank infrastructure, regulatory infrastructure, … etc. This challenge is compounded by poor market profitability and network effects associated with existing money services providers (agents, money lenders,  foreign remittance, …).

For context, let me provide a very short primer. Poverty alleviation and financial inclusion is a primary focus of the world bank and many independent aid organizations. They come together in many areas, with CGAP serving as a key organization for collaboration. Micro Finance has been a key focus for this group over a number of years. A key “model” MFI is Grameen Bank, particularly after Muhammad Yunus won the Nobel Peace Prize in 2006 for his work there. There are 2 points I want to make on MFIs: they are “sustainable” at the margin and use very little technology (predominantly paper based in much of the world). For those interested in more detail I encourage a review of these 2 articles

As a banker and VC my immediate inclination is to recoil at any business which is not profitable. Profit is a sign of health of a business, if you don’t have it.. you die. However the objective of “aid” money is not profit, but rather to maximize the “impact” that every dollar of aid has. We all know the successful Aid examples of DDT, immunizations, pre-natal vitamins, .. etc. What happens when “aid” and NGO money floods into “banking” activities? Does it accelerate banking? Suppress margins? Create sustainable businesses or infinite dependencies? What is the right thing for Aid groups to invest in? Does Capitalism work in emerging markets?

Given that the US and UK dominate the Aid organizations, you would think that the last question would have an obvious answer. However, imagine yourself working in an Aid organization for 20 years, with very little time in the private sector. Everyone is biased by their life experience and in this case it is no different. Suffice it to say that there are tremendous differences in views and experience when compared to the private sector. These differences could become strengths if there was effective interaction between sectors (ex. CGAP’s market knowledge and Citi’s G2P Payments capabilities).

In my view there is much room for improving public/private collaboration, and many current Aid based efforts are at risk of negatively impacting market growth and adoption of sustainable commercial enterprises. One of the primary negative effects is subsidization of poor ideas. There are very limited market forces driving Aid based projects. Aid/NGO subsidies (note this is not investment) in commercial activities influence both price of services/products, the entities that deliver them, and consumer adoption. While the goal of Aid is to maximize “impact” the goal of investment capital is to provide a return, and hence sustainability. At a minimum, Aid groups must ensure that they have a team with experience in the private sector.

As I stated in MNOs will Rule in Emerging Markets, mobile operators are the first commercial organization to develop a sustainable model that serves the worlds poor. MNOs are clearly not philanthropists, they are focused on profitably serving their customers. MNOs have built both a physical communications network, and an agent distribution network that has driven their explosive growth. So while banking is the world’s second oldest profession, mobile operators are perhaps the newest. What happens when the 2 get married?

There are many, many groups seeking to take advantage of both of the MNO assets above. Both of these assets are networks and, as with any network, they are aligned to deliver value along well defined value proposition(s).  In my previous blog Will RBI Disintermediate Agents, I detailed the implications of hijacking the agent network for payments. The communications network is also an asset that can to deliver other services, it is a tool for “inclusion” as well as communication.

Mobile presents 2 primary “disruptive innovations” to the world’s second oldest profession: 1) Access/Cost to Serve and 2) Acquisition. Let me emphasize, mobile does NOT present a “silver bullet” solution to banking. Bank products must still be profitable. In emerging markets, banks have a very poor reputation at the base of the pyramid. Banks are limited in their ability to develop products which can be priced and distributed at the base of the pyramid, not just in emerging markets, but here in the US as well. Mobile banking will not solve this problem, but only allow poorly suited banking products to reach more people at a slightly lower cost. Although mobile does not significantly impact existing banking models, it may allow for the development of a “new products”, one of which is payments.

As I stated in Banks will Win in Payments, retail banks historically focused investment in credit related payments and treated DDA payments as a cost to retain the deposit account. Future mobile payments plays (bank driven) would center around a simplified transactional account to allow for cash in/out, domestic remittance and bill payment. This is not a savings account, nor is it a typical DDA. The closest existing product is a pre-paid card.. and there is a bank behind every pre-paid card in the world. Bank PPC revenue is driven by net interest margin (NIM) on non-interest bearing balance as well as transaction and account fees. A cardless mobile payment product has the opportunity to bring down cost to serve by eliminating plastic issuance, customer communication and account opening (ex. KYC at Agent). The world wide explosion of pre-paid cards should correlate well to the future explosion of mobile payment accounts.

In Pakistan, UBL/Omni is pursuing a bank led approach to this opportunity while Telenor purchased Tameer Bank to pursue an MNO led approach. I’m somewhat biased here, but the reasons I like Omni: it is “open” and can support multiple MNOs, interoperates with existing bank controls, full regulatory support, path to growth into more complex account types.

Conflicting priorities

I have never met an Aid organization or NGO that likes pre-paid cards. It seems their perspective has not changed in this new mobile account type. While I don’t fully appreciate their definition of financial inclusion, a non-interest bearing payment only account does not seem to qualify. CGAP/NGO needs and priorities would be irrelevant if their grants did not invest in competing models. One of their core issues is “closed” networks: Aid organizations hate them.  But as stated previously, every network begins with delivering commercial value to at least 2 parties.

History has shown that closed networks form prior to open networks (in almost every circumstance) as closed networks are uniquely capable of managing end-end quality of service and pricing. This enables the single “network owner” to manage risk and investment. How can any company make investment in a network that does not exist, it cannot control, at a price consumers will not pay, with a group that can not make decisions or execute? Answer: Companies cannot, it is the domain of academics, governments,  NGOs and Philanthropic organizations.

The success of MPESA, GCASH, UBL/Omni, Oi Paggo, .. clearly indicates that payments is a valuable service to the base of the pyramid. These are successful networks that have developed a specific value proposition. Aid groups have “impact” objectives which do not necessarily align to profit objectives of these networks. Opening a network in order to deliver a non-commercial value proposition is not an easy task.

As stated in Cash is King, I’m a pragmatist who firmly believes that the best approach to serving the unbanked is supporting a model where at least one entity has an economic incentive to invest. This is the definition of sustainability. The alternative to economic sustainability is unprofitable zombie shells that require continued aid and investment.

As I have stated previously (see Mobile Money: MNOs will Rule in Emerging Markets and Mobile Money: Emerging Markets/Emerging Models) MNOs operating in closed systems appear to be best positioned for creating a sustainable value proposition to the unbanked in next 2-3 years. My trip to Dubai also shows that a fantastic regulator and bank team can create a new bank product as well (UBL/Omni). 

Items for CGAP/NGOs

  • Investment in commercial efforts amounts to subsidization and “picking winners”. Are you operating as a VC? Be cautious of destroying a valuable service to the poor by compressing margins for entities that do not receive your grants.
  • Stop with the “openness” requirement. Closed systems must develop first… the biggest failure will be India’s common platform initiative. Who wants to invest in that?
  • Policy advocacy and best practice are win/wins
  • Don’t force the consumers into MFI deposits through mobile money. Help with marketing.. yes.. but be careful what you advocate. There is very little market data to support unbanked demand for savings.. it would seem they would rather buy a goat.
  • Don’t belittle or begrudge commercial efforts. What you want to encourage is sustainability and investment … the elimination of grants.
  • Every now and then.. perhaps you should get at least one person on your team with a private sector background. 

Collaboration Needed

The UK’s DFID was an excellent model for Aid, channeling it through a group (Vodafone) that could deliver a “prospective” solution for MFI interoperability. What really makes this model a success is that DFID provided flexibility in “impact” and allowed a commercial organization (Safaricom) to refocus MPESA based upon market needs and adoption. Remember neither DFID nor Vodafone ever anticipated the “payments” use until after the solution was implemented and in the market. DFID acted like a VC.. chartering a COMMERCIAL team to make it work.

There are several conversations which prompted this blog, which I can’t detail as my goal is not to deride the AID groups.. but rather highlight the challenge in investing in mobile money within emerging markets. Quite frankly I was shocked at the attitude of Aid/NGO organizations with respect to commercial initiatives focusing on unbanked needs (ex. SKS Microfinance). The idea of private money creating businesses that serves the poor at a profit was an anathema. The theme of Aid groups view on SKS’s efforts was “greedy capitalists, they just don’t understand microfinance”. Knowing SKS and their investors, this view could not be further from the truth.

As an independent 3rd party the NGO/Aid view may have been driven by a lack of experience and respect for the private sector. While I greatly appreciate their service to a worthy cause, they have a very biased view of solutions, business and economics. Differences in approach are frequently driven by differences in goals: Aid groups want to maximize impact, SKS wanted to build a sustainable business. The real issue is not the divergent views, but the divergent goals and the money being spent to pursue them.

Unbanked: Cash is King

While I was consulting w/ regulators and banks in Malaysia, I asked about the penetration of cards. The response from a lead banker was “Cash is King”. This response is a great summary for the key issues facing MNOs, FSIs and Regulators attempting to improve electronic payment penetration in emerging markets.

Tackling regulatory and consumer issues in emerging markets

While I was consulting w/ regulators and banks in Malaysia, I asked about the penetration of cards. The response from a lead banker was “Cash is King”. This response is a great summary for the key issues facing MNOs, FSIs and Regulators attempting to improve electronic payment penetration in emerging markets. Adoption of new payment mechanisms in developed countries has historically taken 20-30yrs. Emerging markets will surely proceed at a faster pace, but the work to be done is greater given the absence of: regulations, consumer protections, and electronic/physical infrastructure (among both banks and MNOs).

“Cash is King” may be too much of a generalization to extend to all markets, but in Malaysia consumer research indicates there are substantial consumer hurdles for FSIs trying to capture the unbanked population (trust, access points and overall committed to cash chief among them).  For domestic FSIs in SE Asia,  the consumer data shows that  MNOs are better positioned (reputation/brand/service/efficiency) to deliver on the mobile money proposition.  MNO’s position stems from the value that they deliver, with mobile money serving as the principle mechanism to retain access to MNOs services AND move from “informal” communication to money centered “business” communication. MNOs in emerging markets therefore have a unique opportunity to attract consumers to mobile centered “value store”.

Software providers (ISVs) attempting to address the “unbanked” world will face the following challenges:

  1. MNOs are adept at software development. Look at MPESA, GCASH, ZAP, …
  2. Business case separate from MNO is very, very challenging. Payments is a difficult business for banks.. it may be an impossible business separate from either bank or MNO.
  3. No private investment capital. NGO and micro-finance organizations I have spoken with are highly skeptical of technology use for unbanked (even for loan officers). Further, their involvement suppresses margins as government resources are allocated to achieve goals that are not following a profit motive. ISVs will need to make difficult decisions on whether to focus in the “For Profit: of “Not for Profit” areas.
  4. Many willing to listen to your idea, or let you prove out your value.. without much commitment for revenue.

This is not to say that there are no ISV opportunities in emerging markets. Once value is stored in the network businesses will certainly attempt to connect in order to attract and service customers. This is where developed country ISVs have excelled (HK, SG, AU, Korea, Japan, EMEA, …). However, the developed countries had a well established banking infrastructure PRIOR to channels like internet and mobile (with a commensurate evolution in the respective regulatory regime). Within emerging markets the “starting point”  is different (BOTH telecommunications AND banking services are immature) which may result in a different evolutionary path for mobile, banking, payments and regulations. Message to VCs: question your assumptions and adjust your paradigms.

A number of ISVs are attempting to establish a turn key payments system (the mobile money “switch”). However, Banks and MNOs business models are historically centered switching, and hence these established entities are highly motivated to continue control of both the infrastucture and all IP around it (opportunities for ISVs in this space may be limited). Fertile markets for ISVs may tend to be in areas which support either businesses or consumers in mobile commerce. Examples:

  • Hosted service that allows African governments to send pensions to multiple mobile banking plans
  • Text based “comparison” services for consumers,
  • Mobile banking infrastructure (ex: open new account, credit score using social networking data)
  • Mobile “bill pay” services for utilities

Regarding technology use in unbanked… Perhaps “unbanked” is too large of a segment.. perhaps we should separate out sub-groups like  “unphoned”… and consumers that own a phone but are committed to cash only (?traditional unbanked?). Given that some readers of this article may represent NGOs and governments that are focused on use of technology in microfinance, it is important to deliniate segments served by MNOs and MFIs. Perhaps creation of a segment such as “micro finance unphoned” MFU segment is necessary (I would love to see consumer demographic data here). The MFU segment is being successfully served without technology in lending models firmly established (See Grameen model).  Given this “success without technology” NGOs are particularly skeptical of the use of any additional costs (or intermediaries) to serve these consumers. Established (for profit ISVs) vendors will be challenged to create a sustainable low margin business in the MFU space given the influence of NGOs, and subsequent margin compression.

Focusing on “unbanked”, exclusive of the segments above, the entities most capable of tackling the range of issues here are: MNOs, large banks, large retailers, and state agencies. “Trust” is something earned over many years… In emerging markets, I would expect to see very simple services that can have very broad impact, with very little assistance from external vendors for following reasons:

  • Nature of network effects are that you must deliver value to everyone on the network (whether a bank or an MNO). Successful networks must have established physical distribution points.
  • Objective in payments is to establish use and acceptance. Example, receive your pension… now establish a savings account, or send money to your grandson.
  • Simplicity lends itself to better risk management, a key for reinforcing the “integrity” of a new payment system. Solid risk management is even more pronounced in the face of new regulations.
  • CEO visibility with MNOs, Banks and Retailers. Paying a “US Vendor” for anything relating to a payment function is not likely. Citi mobile teams have built tremendous SMS applications in weeks (sorry Silicon Valley).
  • Government Visibility. In addition to CEOs, governments and regulators are highly involved in addressing the needs of their citizens, whether “unbanked” or “unphoned”. Regulators globally are looking to share learnings from Kenya, Philippines, India, … Banks expect between 600M-800M people will gain first time access to financial services over the next 8 years. A tremendous market, that will be served much differently then banks (and retailers/MNOs) have operated in the past.
  • Consumer education…. Simple ( SMS). Side note: Did you know that there is a 20% failure rate on SMS in India? Perhaps this is old data.

Side note… Food for thought.

In this CGAP article, is it really access to “cashless payments” that is the issue? or is it the farmer’s inability to find a market for the goat and safely transfer/store the value? The deaths of the SKS workers are truly unfortunate, but if mobile enables value store, won’t thieves then adapt to this opportunity and force a transfer at knife point? Think of the poor farmer with all of his savings locked in his cell phone, overnight the money disappears. What consumer protections are in place so that he gets access to his funds immediately? Indian regulators are tackling these issues today, issues that the developed world has continued to refine over the last 40 years (for electronic payment).

Challenges for ISVs are many, as MNOs are very adept in software development and any “mobile money” value prop is Asia must be either strongly tied to a bank or MNO. VC is very tight here because compressed margins in payments are further exacerbated by injection of government and NGO money.

Feedback appreciated.

The Power of Mobile Money..

Economist Article

Telecoms: The power of mobile money | The Economist

 Extending the “network” of financial services into the unbanked is a tremendous challenge. Modern G20 countries have developed significant legal, regulatory, and technology infrastructure over 100 years. Such basic elements as customer identification for KYC, or consumer protections are not in place within many 3rd world countries. Mobile money attempts to leverage the “mobile network” as a financial services network. The telecos (appropriately) are driven to enable mobile money services to provide a way for the “unbanked” to pay their bill. As long as the value stays in the teleco network there are few issues. However, when “cash out” points are established then the same regulatory issues will need to be addressed and decisions made as to whether to “connect” the mobile network to bank networks. 

Anyone familiar with the subject knows that African regulators are particularly sensitive since the success of MPESA. Any success in mobile money that results in value exchange external to the mobile network will be facing the same regulatory requirements that banks do. In short, the “mobile networks” will not be morphing into banking networks without compliance to the same bank regulations which all financial networks face.

In speaking with both the FSI and the Network involved in MPESA, I asked them both separately what assistance they were looking for in Kenya, or if they rolled it out in another African market. Both separately said “someone to own the risk” [e.g. payment risk management]. Providers are thus recognizing that Payment authorization will require a new risk models then what are currently in place within other payment networks such as cards (e.g. HNC’s Falcon). Note that banks have significant dedicated risk teams (20-50 people) focused here.