A kiosk for Zoona, an Zambian mobile money system that helps entrepreneurs and ordinary people transfer money.
A kiosk for Zoona, an Zambian mobile money system that helps entrepreneurs and ordinary people transfer money. (photo courtesy Zoona Archive)

In the last few years, fintech startups have become one of the hottest tickets for venture investors. Inc. magazine called fintech “one of the most promising industries of 2015.” Companies like Fundbox, CommonBond, and Prosper are closing multimillion-dollar rounds. VCs have put $23.5 billion into fintech in the last two years, and now investment banks are homing in.
Omidyar Network, where I work, has invested in Prosper and numerous other fintech companies. But for us, this is more than the latest trend for investors seeking big multiples. The entrepreneurs starting these companies and the funders backing them know that fintech is about something. As The Economist put it, “The fintech revolution will reshape finance—and improve it.”
That’s because fintech startups promise to dramatically lower costs and make financial services more accessible to people who are not reached by traditional financial services today, especially (but not only) in emerging markets. And serving these populations can be profitable. As we explain in our new report Frontier Capital, fintech is an important frontier for investors seeking social impact while generating strong returns.
In emerging markets, there is vast untapped potential in serving low- to lower-middle-income people, or those making above $2 and below $8 a day. Their incomes have historically been thought to be too low for many traditional investors, but too high to be reached by those impact investors who are focused on the bottom of the pyramid, i.e., those earning less than $2 a day. Yet, these people who are in between the very poorest and the existing middle class live constantly at risk of falling back into poverty. They lack secure savings, insurance, or well-timed loans—in other words, the formal products and services that are increasingly being introduced by innovative startup fintech companies.
And with steadier incomes and more disposable income than those at the very bottom of the pyramid, these consumer segments can be reached with business solutions. In Latin America alone, their purchasing power is estimated to be over $400 billion. Worldwide, across emerging markets, it’s $3 trillion. VCs are starting to take note. The business models are new, and cannot simply be replicated and adapted from business models that have succeeded in the brick-and-mortar world or in OECD markets. So it requires investors and VCs with an appetite for the unproven model.
Frontier Capital explores early stage risk capital in emerging markets and what it means for entrepreneurs and investors. Based on more than 10 years of experience and $400 million in impact investments, including multiple fintech startups, Omidyar Network found that successful companies operating at the frontier—in fintech and otherwise—usually have two characteristics in common: They are asset light, and often adopt a “mixed income” model.
Keeping Assets Light and Costs Low
Technology is key to serving the low- and lower-middle-income segments. Until the advent of ubiquitous mobile phones and other technological advances, it was nearly impossible for financial services businesses to penetrate this population using existing cost structures. Today, the platform represented by this vast number of mobile devices creates equally vast potential to scale new businesses.
Because of these advances, innovators now can easily start asset-light companies that require relatively little capital expenditure for things like physical infrastructure or equipment. They can thus test and adapt business models more cheaply and quickly, and generate better margins. Our research has found, for instance, that mobile wallets reduce the lifetime cost of providing a consumer financial account by 85%, so technology-based financial service businesses can reach break-even faster than any brick-and-mortar bank.
Another example includes the dozens of fintech businesses that are dramatically reducing the cost of serving lower-income consumers who, especially in emerging markets, may not have a traditional credit history. As we have laid out in another recent Omidyar Network report, Big Data, Small Credit, companies like Lenddo and Cignifi are using big data—from mobile and smartphone usage and social media behavior—to assess creditworthiness and revolutionize unsecured, small-ticket, short-term consumer lending. These new methods of scoring consumers can reduce cost by as much as 40%, making many new emerging market consumers “visible” for formal credit for the first time in places like Colombia, Philippines, Brazil, or India.
This lower-cost platform makes fintech startups more likely than most businesses to take the non-linear growth path that makes for VC home runs. MicroEnsure, for example, partners with telecom operators to sell affordable life and health insurance via a freemium model to over 15 million low- and lower-middle-income consumers across 16 countries in Africa and Asia. It expects to reach 26 million in 2018. The disruptive potential of MicroEnsure has already attracted investment from two major global insurance companies (AXA and Sanlam), which have a combined market cap exceeding $55 billion.
Economies of Scope and Scale
Beyond the consideration of cost, we call business models that simultaneously serve lower- as well as lower-middle-income consumers in emerging markets as “mixed-income” models. It’s easier to achieve scale and reach lower-income customers when companies also serve middle-income customers with mass market offerings.
By targeting larger markets, these businesses are more easily able to achieve economies of scale and scope, driving down prices. An analysis of MIX Market data suggests that young, for-profit microfinance lenders relying on a variety of business models but with a lower percentage of clients below the poverty line tend to generate higher returns. This does not mean cutting out poor customers, but rather serving a larger pool that includes mixed-income segments.
Early on, as documented in Big Data, Small Credit, fintech businesses are more likely to find early adopters of their technology among the middle class, allowing them to prove their model and kick-start their growth. These consumers understand and value services like credit, but many often don’t have access to such formal services despite being middle class or aspiring to be. Lower-income consumers are generally more risk averse when it comes to adopting new innovations. Smaller incomes put pressure on every penny.
But once a business has gained traction with early adopters, it’s easier to convince lower-income customers to come aboard. In Kenya, for example, Safaricom first marketed its wildly-successful M-PESA to the young, urban middle class. For its first two years, the mobile money system was predominantly adopted by these tech-savvy customers. Within another three years, however, 72% of M-PESA’s customer base lived outside Nairobi and earned less than $1.25 per day.
But Are There Returns?
With so many paths to success, fintech ventures can generate strong returns for investors, with some very well-known home runs in and outside of payments—like Lending Club and Fundamo—already headlining the sector. Meanwhile, frontier capital funds like Elevar Equity and Lok Capital have earned returns of 2x and 3x with investments in companies serving lower- and middle-income customers. Their investments include fintech startups as well as companies in healthcare, education, and agriculture.
Fintech is hardly a panacea. It won’t solve all social ills. There won’t always be home runs or unicorns. And it takes a lot to get these new business models right.
But when fintech gets it right, it offers investors not just the opportunity to earn healthy returns from rapidly-scaling businesses that bend the cost curve, but also to take part in a global shift of how people borrow and save, pay each other, and manage their money. For people who reside on the periphery of the financial system, technology-based companies with low-cost solutions can indeed generate truly transformative social impact.
Mike Kubzansky leads Omidyar Networks’ Intellectual Capital team, responsible for defining investment strategies and conducting market research and analysis. Read the Omidyar Network report “Frontier Capital: Early Stage Investing for Financial Returns and Social Impact” here. “Big Data, Small Credit: The Digital Revolution and Its Impact on Emerging Market Consumers” can be found here.