The emergence of billions from subsistence farming into a global middle class is both a) the biggest investment opportunity of the 21st century b) the cause of so much of the trauma (political, social, geopolitical) roiling the world today.
In short, there is a lot at stake in those two words – financial inclusion – and in the technology that is driving financial inclusion today.
Financial inclusion used to mean a) philanthropy b) governments telling banks to serve more poor people. That was analog financial inclusion and it was and still is very helpful. What we are focussed on is digital financial inclusion, which is more to do with mobile and blockchain. Digital financial inclusion is accelerating the way billions move up the ladder of opportunity.
7 billion in 6 tiers playing snakes and ladders
There are about 7 billion people in the world today. We can look at this with a glass half full point of view as a ladder of opportunity. Or we can look at this as a glass half full point of view as snakes that the unfortunate slither down into poverty.
Being an entrepreneur, I tend to have a glass half full point of view. If you are in one of those middle tiers and see how your earning ability is being hurt by billions around the world competing for labor, you can rail against foreigners taking your old job or find a way of trading with those foreigners or working for a firm that trades with those foreigners (or find work that is immune from automation and has to be done locally).
The economy needs growth. That growth will come from billions entering the global middle class as long as global trade remains open. The problem is that the climate needs us to stop driving that growth with C02 emitting fossil fuels. Again we can have a glass half full or empty point of view. Glass half empty = we must stop those billions entering the global middle class because that growth will kill the planet for all of us. Glass half full = we must find profitable ways for billions entering the global middle class to use clean, renewable energy and that is a huge business opportunity.
Note: many of the examples that follow come from India, mainly because I happen to have lived and worked there so I can speak from experience, but the challenges and opportunities apply to all the Velocity 12 countries (more on them later).
The 6 tiers, starting from the bottom are
Tier 1 = Subsistence. This is the world of philanthropy, such as the amazing Bill & Melinda Gates Foundation. It is ensuring that people are healthier and better fed, with a focus on things like malaria and sanitation. The success of these initiatives puts more people onto the next ladder.
Tier 2 = Unbanked. Bill Gates famously said that “banking is necessary banks are not”. In this tier, banks as they exist today are irrelevant. The classic customer is a day labourer working in a metropolitan area and remitting money back to their home village and buying mobile pre paid services and other low cost services. Those remittances are not always the cross border remittances that Fintech fans like to talk about. These cross border remittances have regulatory hurdles. In big markets such as India, the domestic remittances market is also big and being within a national border the regulations are easier. The unbanked use “feature phones” (aka “dumbphones”) and transaction unit sizes are typically too low for bank payments rails (you need to make money on a $1 transaction or less). Visiting a bank branch or ATM is not something this customer tier considers and if they did banks would find them to be unprofitable customers. These customers want basic payment services at very, very low cost. This is the world of services such as M-Pesa and, in India, MoneyOnMobile (Disclosure MoneyOnMobile is a client of Daily Fintech Advisers, our earlier coverage here). The people in this tier who work hard and save diligently may move up to the next tier.
Tier 3 = Underbanked. They need the same ultra low cost basic payment transactions as the Unbanked. They do more volume and slightly higher per unit transactional value, but their needs are fundamentally the same. They are formally in a different tier because they are classified as having a bank account. Although now formally in the tier marked as “banked”, they almost never use an ATM or credit card or other bank service and as far as banks are concerned they are unprofitable customers. In countries such as India that have an active government policy of encouraging financial inclusion, many will be paid via pre-paid debit cards or mobile wallets. They need to use this digital cash to a) pay for for basic goods and services via pre-paid mobile wallets and b) remit money home and c) get physical cash back from retailers (so they can buy the goods that you can only pay for with physical cash (more than 90% of the economy in a country like India). This is the tier where world of services such as M-Pesa and MoneyOnMobile intersects with services based on smartphones and credit cards that come from the West. This tier also applies to the West. There are people in countries such as UK and USA that might have a bank account but almost never use it because they mostly live “hand to mouth” and banks don’t want their business. This is the world of pre-paid services such as Ffrees in UK and GreenDot in USA.
Tier 4 = Banked Middle Class. This is the world of traditional Retail Banking and the more recent Neobank entrants. The supply is obvious. The demand is less obvious. Who woke up this morning in the West and put “change my banking provider” into their top Must Do priority list? In comparison millions of people in tiers 2 and 3 wake up each morning and things like “top up my mobile phone minutes” or “send cash home to my family” are on their top Must Do priority list. Look at the data in India. Tiers 2 and 3 are about 850 million vs about 300 million in tier 4. As people climb the ladder of opportunity, that 300 million Middle Class will grow. However it is unlikely that, having used the services designed for Tiers 2 & 3, they will desert them for traditional banking services.
Tier 5 = Overbanked Wealthy. Not relevant to this analysis, other than as Impact Investors.
Tier 6 =The Super Rich. Not relevant to this analysis, other than as Impact Investors.
Velocity 12 – the countries formerly known as emerging
The names have changed from third world to developing world to emerging markets to BRICs to high growth markets to The Rest (of the World). The latest is the Velocity 12 designation by Ogilvy. I like it because a) “the countries formerly known as emerging” is too long and b) it denotes rapid growth opportunity as the most fundamental characteristic. If I had to choose one simple word it would be the Rest (of the World).
These markets are now the driver of change. This is the mega trend that we call “First the Rest then the West”. One simple but powerful innovation that has gone from Rest to West is the dual SIM phone, which started in India.
Quoting from the Ogilvy report:
“The 12 velocity markets identified herald a shift to South Asia as the epicenter of future middle-class growth. Centered principally in India, but inclusive of Pakistan, Bangladesh, Myanmar, Indonesia, and the Philippines – and extending up to China, and to Egypt, Nigeria, Mexico, and Brazil in the other direction, the Velocity 12 markets represent a vast arc of future growth. Over the next decade, these 12 markets will be the source of the next billion middle-class consumers, which will create a critical tipping point as the middle-class move from a minority to the majority of the local population in many of these markets.
Miles Young, Ogilvy & Mather Worldwide Chairman said, “The Velocity 12 research shows the world as it will be in the not too distant future. A billion new middle class members will literally change its shape. It will become, for instance, much more orientated to South Asia, especially India. Most Western businesses simply are not used to thinking this way. This means finding a new lexicon of growth, as the phrase ‘emerging market’ doesn’t now describe the new realities. ‘Velocity’ better describes the real transformation in these markets.”
Tipping point theory
When economies move up this ladder of opportunity it happens very fast and there are behavioural economics feedback loops. For example in Tier 1, all the incentive is to have lots of children who will look after you in old age. Somewhere between Tiers 2 and 4, the motivation changes to having a smaller number of children who are well educated and cost a lot of money to raise. As these well educated grown up with high expectations start producing and spending, it lifts those economies and all who trade with or invest in those economies.
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