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Fintechs for LMI segments – What’s the intricate puzzle?

Posted on by MSC

In 2017, J.P.Morgan commissioned MicroSave and IIM Ahmedabad’s Centre for Innovation Incubation and Entrepreneurship (CIIE) to undertake a study on the fintech  landscape in India. This comprehensive study focused on the low- and middle-income (LMI) segments in the country. The research team consulted over 60 stakeholders spread across various industries, institutions, leadership levels, and geographies. The research sample had representation from fintechs, incumbents, investors, donors, industry bodies, experts, regulators, government and allied bodies, and incubator and accelerator managers.

We have captured the findings of the study in three blogs – this being the first in the series. This blog covers the definition of the LMI segments, the fintech landscape in India, and the challenges that prevent various players like fintechs, incumbents, and investors from catering to these segments. The second blog in the series highlights the potential opportunities present in the LMI market and how the current fintech ecosystem is approaching an inflexion point. The third blog highlights seven potential ways in which the fintechs can serve the LMI market and unleash its potential.

To read our report on the fintech landscape in India, click here

To know more about the Financial Inclusion Lab and to apply, click here

 

Understanding the LMI segments

For the research, we have categorised the LMI segments based on daily household income. A snapshot of the entire population including the LMI segments is as follows:

The current trend and focus of incumbents and fintechs suggest that the top of the pyramid is financially well-served. However, the bottom-most segment, that is, the ultra-poor, is currently not ready to use and adopt most of the fintech solutions. The middle section of the pyramid, which comprises aspirers and strugglers, is classified as the LMI segments. Our analysis suggests that it is this middle section of the pyramid that offers an expansive new market for fintechs. The skewed focus of fintechs on the elite and affluent segments leaves an addressable market of ~320 million (84%) LMI customers untapped.

The fintech landscape in India

Over the past few years, there has been a growing influence of fintechs in India. The fintech landscape has seen rapid growth in terms of numbers and reach, as well as investments in fintechs. According to a 2017 PwC report, there are more than 1,500 fintechs in India. Two-thirds of them started in the last two years. An earlier KPMG report from 2016 estimated that the transaction value for fintechs in India would increase from USD 33 billion in 2016 to cross USD 73 billion by 2020.

As expected, the fintech sector continues to witness acquisitions for a variety of reasons. This has mostly to do with a tendency within the fintech sector to deriving synergy and consolidation. Our analysis of data from Tracxn suggests that between 2011 and 2017, there have been 27 notable acquisitions in the fintech sector in India. Some of these include FreeCharge by Axis bank, PhonePe by Flipkart, and Citrus by PayU.

From the data, it appears that the fintech sector is growing. However, it is restricted to certain geographies and service lines. Moreover, only a few large, established players are able to emerge and receive major investments in India.

As per the data from Tracxn, 82% of fintechs are located in the three metro cities, that is, Delhi-NCR, Mumbai, and Bangalore. Moreover, a significant proportion (57%) of fintechs offer either payments and transfers or personal/business credit products. This leaves behind savings & investments, and insurance products. The analysis also suggests that since 2011, 87% of the total investment in the fintech space has gone into fintechs that deal with payments & transfers, and credit products. Moreover, the investment pattern is highly skewed towards select fintechs. For instance, 75% of the total investments since 2011 have been made in only 10 fintechs. Of these, Paytm alone cornered 47% of the total investment. Moreover, most of the fintechs receive large investments at an expansion stage, that is, at the Series D, E, or F stages.

Our research suggests that most fintechs serve only the affluent, tech-literate customers in tier-1 geographies. These fintechs typically serve two types of non-LMI personas – millennials and micro-entrepreneurs. These personas have the following characteristics

Challenges in catering to the LMI segments

While our research indicates that there is a huge opportunity in the LMI market, the current fintechs have not been able to yet tap this effectively. This is due to multiple challenges that they face in their understanding of the pulse of the LMI segments. Some of these challenges are:

In general, investors understand the value that fintechs create and assess the viability of their business models.However, when it comes to the LMI market, investors have their own apprehensions due to a host of factors.

Most investors continue to look at the per-unit economics for investment and remain sceptical if this would work in the LMI market. Their go/no-go calls for investment decisions are generally driven by metrics of the long-term value (LTV) of a potential customer against the cost of acquisition (CoA). A thumb rule that is used is LTV/CoA > 2.

Although there are various challenges that fintechs and investors face in serving the LMI segments, there are players like microfinance institutions (MFIs) and public sector banks (PSBs) that cater to these unserved and underserved segments. Like other players, in a few years, some fintechs might be willing to look beyond the opportunities in the non-LMI segments and make a dent in the LMI market. This, however, is likely to happen only if fintechs and investors recognise that there is sufficient opportunity in the LMI space and are willing to increase their risk appetite and invest for a long gestation period. This is the subject matter of the next blog where we highlight key insights drawn from the positive experiences of players that operate in the LMI market.

i Fintech is a hybrid of financial services and technology. Fintech refers to technologically driven innovations that support or disrupt the existing financial system to improve the delivery of existing financial services and offer new financial products and services to consumers in an economically viable manner. Fintechs are technology-focused or technology-led start-ups that use or provide modern, innovative technologies.

ii There are 600 million people in the LMI segments in India. As per the 2011 census, 62.5% of the population falls under the working age group, that is, 15–59 years. As a result, there is an addressable market of ~380 million in the LMI market. Assuming that fintechs in India serve ~200 million customers of whom 70% (140 million) belong to non-LMI segments while 30% (60 million) belong to LMI segments, there are ~320 million untapped customers in the LMI market.

Fintech Study to Model a Financial Inclusion Lab

Posted on by MSC

The current landscape suggests a growing influence of fintechs in India. However, growth and investments have primarily confined in the payments and credit domains, and in a few metro cities. Most fintechs serve the affluent, tech-literate customers in Tier-1 geographies, leaving over 80% of the addressable low- and middle-income (LMI) customer market untapped.

While the LMI segment offers a blue ocean for different stakeholders such as fintechs, investors, donors and incumbents, there exists a significant disconnect between fintechs and investors, and fintechs and incumbents. Moreover, most incubator and accelerator programmes in India are sector-agnostic, and offer standardised, light-touch and shallow support with no focus on the LMI segments.

This report highlights the support areas for fintechs to offer convenient and affordable financial solutions to the LMI segments. It also proposes to set-up a dedicated ‘Financial Inclusion Lab’. The Lab will provide high-touch, immersive consulting, catalytic support, and customised services to early-stage fintech start-ups in India.

Mobile internet access – the next frontier for ‘Tech’

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The ‘tech’ revolution depends on internet access

The tech revolution is being heavily promoted as the answer to many of the development challenges with which we have been struggling for so many years. These advanced tech solutions can potentially address pressing issues related to financial, agricultural, educational, health, and enterprise sectors, among others. The vast majority of these advanced tech solutions, however, require connectivity to realise their full potential. They need both access to 3G+ or internet coverage, which is often limited in rural areas, as well as a phone that has unfettered access to the Internet.

Smartphone penetration has been rising – slowly

The past five years have seen a rapid fall in the prices of smartphones. Some of the best deals in Africa are available in Kenya. Here, the average price of a smartphone has more than halved from the KSH 23,100 (USD 270) in 2013 to KSH 9,700 (USD 95) in 2016. The lowest priced X-Tigi P3 smartphone is being sold on the Jumia  e-commerce site for KSH 2,799 (USD 27). In April 2017, The Business Daily reported that “Smartphone penetration in Kenya has grown to more than 60% of the population over the past five years thanks to the influx of affordable phones.” It also noted that “smartphone sales were heavily concentrated in urban areas”, which is hardly surprising given the 3G+ coverage in the country.

But Kenya is a positive outlier. GSMA predicts that the global mobile internet penetration may only rise from the 2017 level of 43% to 61% by 2025. Unsurprisingly the rates are lower for sub-Saharan Africa, which was at 21% in 2017 and is predicted to rise to 40% by 2025. In India, the rapid rise in smartphone penetration rates are projected to fall quite significantly over the next couple of years – and potentially further beyond (see graph). Once again, the urban areas have now been largely saturated, leaving rural areas with little or no 3+G coverage as the potential market.

Furthermore, there are three critical issues that we should remember in looking at the data:

  1. Penetration rates typically double-count people with more than two SIM cards – and thus overstate the effective penetration rates. (Although, you may argue that if husbands and wives share a mobile internet connection this would result in an understatement).
  2. Inevitably, the more affluent segments of society hold the vast majority of these mobile internet connections.
  3. The data hide significant and troubling gender disparities. In its Mobile Gender Gap 2018 report, the GSMA notes that: “Women in low- and middle-income countries are, on average, 10% less likely to own a mobile phone than men, which translates into 184 million fewer women owning mobile phones. Over 1.2 billion women in low- and middle-income countries do not use mobile internet. Women are, on average, 26% less likely to use mobile internet than men. Even among mobile owners, women are 18% less likely than men to use mobile internet. The gender gap is wider in certain parts of the world. For instance, women in South Asia are 26% less likely to own a mobile than men and 70% less likely to use mobile internet.”

Navigating smartphones is not easy

We should also note that smartphones are not as easy or intuitive for low-income segments, and particularly for the oral – illiterate and innumerate people. In the words of the Digital Skills Observatory, “Without the right skills, smartphones can exacerbate adoption challenges, instead of alleviating them … The environment that people discover through their smartphones is controlled by a few powerful organizations who play a big role in the apps and services people use, and shape the way people communicate with one another. Inexperience with this world disrupts confidence in smartphone use and causes confusion about digital identity and content consumption and creation. As people begin to use and explore their devices, apps pre-installed by manufacturers or operators cause uncertainty. Their origin is unclear, their purpose is mysterious, and their permanence is frustrating.”

Furthermore, the uptake and use of digital financial services require more than just digital skills to navigate this new world. In addition to ability, users also need awareness, access, and, above all, a real need to stimulate uptake and use. The limited use of basic mobile money services highlights this. The GSMA’s State of the Industry Report 2017 notes that of the 690 million registered mobile money accounts across the globe, only 168 million (24%) were 30 day active.

A substantial proportion of growth in penetration will be smart feature phones

But there is a growing body of evidence to suggest that “smart feature phones” (like the X-Tigi P3) will drive a significant proportion of the rises in mobile phone ownership. In its Q1 2018 report, International Data Corporation (IDC) noted that “the smartphone market will continue to grow in Africa … However, sales are unlikely to reach the rates seen a year or two ago now that many urban markets are becoming saturated.”

As Jake Kendall and Arunjay Katakam highlight in their excellent blog ‘Long Live the Feature Phone’, “… the trend is continuing, YoY, the feature phone market was up 11.5%. Feature phones still constitute a significant 62.2% share of the total mobile phone market (from 56% the year before)”.

These smart feature phones like the Jiophone in India (see box) drive growth because they address several pain-points experienced by less affluent customers who have tried low-end smartphones. A recent Mozilla report highlighted that low-end smartphones have limited RAM, which prohibits running many fintech apps. In addition, they also typically have hopelessly short battery lives, screens that shatter easily, and a persistent problem with ‘fat finger error’ that makes them almost unusable. Furthermore, the cost of data needed to make fintech transactions is usually prohibitively expensive. Indeed, in our fieldwork, we have seen some men in Africa proudly carrying prestigious smartphones but using them only to make or receive calls and SMSs.

However, as Jake Kendall and Arunjay Katakam point out “Probably the most critical limitation is that feature phones do not have an open app store like smartphones. This dramatically limits the ability of 3rd party developers to create new apps and features that can be deployed on these phones. At present, the feature phone landscape is quite broad: there are more than 1,348 models available from 76 manufacturers. These phones run on a myriad of operating systems including several proprietary ones making it very difficult to write apps for these phones as each app would have to be recoded and customized for each phone.”

With even Facebook and WhatsApp rolling back efforts to cater to the feature phone market, it is reasonable to assume that “tech” apps will not be to navigate this challenge … and thus smart feature phones will not be able to run these apps.

So what does this mean for “techs”?

This has significant implications for techs that seek to serve the mass market. Limited mobile internet connectivity has left many digital credit providers relying on minimal top-up and mobile money transaction data to make credit decisions. The results have not been pretty.

Tech providers will need to build systems that use only feature phones such as the MasterCard Lab’s 2KUZE which “places the seller and buyer at an open field of interaction, where prices are negotiated, deals sealed and the agent goes to pick the produce, and once it is received, payment is made either in mobile money, cash or bank payment.” This could, of course, create a much deeper digital footprint for farmers who regularly use the platform, thus improving the data for credit decisions.

The alternative is a judicious mix, with the more sophisticated transactions conducted at agents with smartphones or tablets located in hubs where 3G+ is available and the basic service transactions conducted using feature phones. In the context of fintech, for example, for several years now, MicroSave has advocated differentiated agent outlets. Differentiation involves:

  1. Relatively sophisticated (usually exclusive and dedicated) sales agentsresponsible for selling products, on-boarding customers, and conducting larger value  transactions; and
  2. Basic (usually non-exclusive and non-dedicated) service agentsresponsible for conducting, typically smaller, cash in and cash out (CICO) transactions.

Sales agents would be based usually in higher footfall market towns, with easier access to both 3G+ coverage and bank branches for rebalancing and support – thus allowing them to manage higher value transactions and sales of sophisticated products. To do so they would use either a smartphone or tablet or both. Basic service agents in more remote villages with only 2G services can conduct basic CICO transactions using feature phones.

Similar approaches can be used for agriculture (see The white spaces of the digital divide: 3G+ haves and have-nots), health, education, enterprise, along with a host of other areas.