M-Pesa: PayTech in Developing Markets

The pay tech innovations that

we have reviewed so far, have mostly be concentrated in more

developed markets with well-established financial infrastructure, such as the

well-functioning interbank payment network and telecommunication structure for

credit card transactions. These enabled innovators to focus on

the front end and develop user interface enhancements that make these good

infrastructure easier to use. As a result,

the barrier of entry is relatively low and the market is quickly becoming crowded. Innovators and venture funding have

consequently started to look at other less-developed parts of

the world with less competition. In these markets, for instance,

developing countries in Africa, a good financial infrastructure

backbone is much less developed. This results in a large

number of potential customers who lack

access to the banking or financial system that could potentially be

well-served by new Fintech innovations. So the key question is, can we do that? Can we still deliver good paycheck

service in markets without good tech, where people don't have bank accounts and

don't even have a smartphone. Turns out that the answer is yes. In fact, Africa has been one of

the earliest Fintech innovation hotspots. Think about this, before Venmo and PayPal become widely adopted

in the United States, close to 99% of the population in Kenya

are already using mobile payments. In the next few videos,

we'll see how this is done. Particularly, we'll see how the lack

of good tech infrastructure could be compensated with some really clever

application of sound business principles. This could provide some good lessons for innovators looking to expand into less

developed markets and we'll wrap up this module with some advice from an expert who

has been in the field of these markets. The system that I mentioned

is called M-pesa and let me give you a brief history

of how it came into being. In 2005, Vodafone,

which is a British telecommunication company with this African

subsidiary safaricom, won a government grant to help

the unbanked population in Kenya. Their original idea was sort of

like the nobel-winning Grameen Bank extending very small micro loans to

the urban workers in the hope of spurring entrepreneurship activity. But soon after, they found a big problem,

the recipients were mostly migrant workers in the urban

areas are not using the loans. They're sending the money straight home

to their families who needed it more. So in many cases, they're taking

the loan money, get on a bus, and travel for days and weeks, the hundreds

of miles back to their families in faraway rural villages and

give the money to their families. And this was quite an expensive and

oftentimes, dangerous journey. With this observation, the focus of

the original program changed dramatically, from extending the loans to make the money

movement process less cumbersome and more efficient for the recipients. And this is indeed a big challenge,

don't even think about bank accounts. The migrant workers were

purely on a cash-only basis. There are no computers and

they didn't have smartphones either, but rather use the basic feature phones that

could only do calls and text messages. And most of them were not financially

literate enough to understand the intricacies of mobile

payment platforms, like PayPal. Given these challenges an innovation that

helps them move money more efficiently and not having to physically travel

the hundreds of miles is the classic definition of financial inclusion. With a potentially high marginal impact

on the financial well-being of this unbanked population. At the same time, this could be

good business, because these people represent a large untapped revenue

source for both the core and other value-added services once they're

included in the financial system. The solution is M-pesa, one of the most influential mobile

payment systems in the world. And this is what it looks like,

let's see how it works. Without customer accounts and

smartphones, the core idea of M-pesa is very different from other mobile

platforms like PayPal or WeChat. In fact, it traces back to the old hawala

system dating back thousands of years ago. The hawala is kind of like the working

men's Bitcoin, a form of underground money transfer service operating on

a sort of black-market honor system. And in modern times, it is often used for

illegal money laundering purposes. This is how it works, suppose a person

may be a criminal located in country A, wants to serve wants to send money

to another person in country B, without going through

the regular banking channel. To complicate things, suppose he has

dollars and the recipient needs euros. To facilitate this transaction,

we're going to need two agents called hawaladar a located physically

in each of these countries. And each would have a stash of dollars and

euros available. So the sender would give the dollar

to the agent in country A and call the recipient with a secret codeword. Then the agent in country A will

call the agent and country B, telling them to simply give

the recipient the equivalent amount of euros if he brings

the correct codeword. And the transaction is over for

the sender and receiver and that could be done over the phone

in a matter of minutes. Settlement between the agents will happen

much later, hence the honor system. For example, they could periodically

settle by physically moving the dollars and euros across the border

by illegal means. As you can see here, although illegal,

the hawala system does introduce a convenient way for the end users

to quickly move money around. And M-Pesa simply took this old idea

of physical agents and customers and replaced the black-market honor system

between the agents with a legal and clever solution based

on market competition. The solution essentially

combines several key concepts, often taught in introductory

business courses, such as monopolistic competition,

newsvendor models and network effects. Compared to other paytech

innovations that we have seen, this innovation is much less in tech,

but much more in business. We'll have a non technical overview

of this system in the next videos.