co-creation for impact investment in microfinance

Strat. Change 21: 71–81 (2012)Published online in Wiley Online Library(wileyonlinelibrary.com) DOI: 10.1002/jsc.1896 RESEARCH ARTICLE

Copyright © 2012 John Wiley & Sons, Ltd.Strategic Change: Briefi ngs in Entrepreneurial Finance

Strategic Change DOI: 10.1002/jsc.1896

Co-Creation for Impact Investment in Microfinance1

Arvind Ashta Burgundy School of Business, Dijon, France

IntroductionIn the wake of the global economic crisis, certain fi rms are looking to developing country markets to do business and at the same time fulfi ll their corporate social responsibility (CSR) towards the poor. Th is echoes the doing well by doing good philosophy. However, as competition comes in, doing well in unknown markets may be risky. Th is paper presents a case study on how venture capital fi rms use the concept of co-creation to create a multi-pronged attack on poverty while maintaining a profi t motive.

Serving the poor as an opportunityIt is often considered that a country is poor because it is poor and that exogenous capital is required to break the vicious circle of poverty (Nurkse, 1952). Th is exogenous capital needs to be complimented with technology transfers and techni-cal services enabling institution building.

Within a country, the poor may need this exogenous capital: “Th e poor people, nobody gives the fi rst dollar to catch the next dollar.” says Muhammad Yunus, the Nobel Peace Prize winner (Yunus, 2003). Part of the reason lies in their lack of human capital and social capital and the inability to use technology, part of the reason lies in asymmetric information keeping banks from lending to them, and part of the reason lies in the small transaction size leading to high transaction costs (Armendàriz and Morduch, 2005).

Yunus foresaw that the poor could get together in groups and thus allow microfi nance institutions (MFIs) to overcome asymmetric information without

Exogenous capital is required to break the vicious circle of poverty.

Venture capital firms use the concept of co-creation to create a multi-pronged attack on poverty while maintaining a profit motive.

Technology companies are realizing that if the poor can use telephones, then that is sufficient for them to get into the field and provide them micro-services which make it possible to lower transactions costs in dealing with them.

Constant checks may help raise health consciousness and increase the productivity of these micro-entrepreneurs and reduce the risk of the microfinance institution.

The poor are requiring not only microcredit, but also micropayments and

micro-insurance as well as health check-ups.

1 JEL classifi cation codes: G20, G21.

72 Arvind Ashta

Copyright © 2012 John Wiley & Sons, Ltd. Strategic Change DOI: 10.1002/jsc

actually getting the information (the poor know who amongst them are bad risks and therefore do not include them in groups). Th e use of social capital to reduce asym-metric risks, increase fi nancing and enhance women’s role in decision-making has been documented (Holvoet, 2005), though sometimes nuanced (Mayoux, 2001; Maclean, 2010).

Similarly, technology companies are realizing that if the poor can use telephones, then that is suffi cient for them to get into the fi eld and provide them micro-services which make it possible to lower transactions costs in dealing with them. One such service is mobile payments (Ashta, 2010) which has grown exponentially and has features of mobile banking (Porteous, 2006; Ivatury and Mas, 2008; Lyman et al., 2008). In addition to mobile telephones, a host of other technologies such as manage-ment information systems, internet development, biomet-rics and credit scoring systems are creating positive impacts on development tools in general and microfi nance in par-ticular (Ashta, 2011a).

Th e outreach of the microfi nance sector is estimated at 190 million borrowers in 2009 (Daley-Harris, 2011) or 950 million people (assuming a family size of fi ve per borrower). Th is is a far cry for the 2.8 billion poor people.

Th e next question is, therefore, how to make MFIs grow in a sustainable manner?

A benchmarking of the fi ve biggest institutions shows that they represent 30 million or 16%. Figure 1 benchmarks the growth of the fi ve largest microfi nance institutions in 2009 over the last seven years (2003–2009) for which com-parative data is available on the Microfi nance Information Exchange (MIX).2 Each of these top fi ve institutions has four million to eight million borrowers. Taking an average family size of fi ve, this represents a combined outreach of 150 million poor persons. Figure 1 also shows that as opposed to the 10% to 15% average growth rates over this period achieved by the top four institutions in fairly saturated markets of Vietnam (VBSP) and Bangladesh (Grameen, BRAC and ASA), the Indian market is far from saturated and still permits growth rates such as the 150% per annum achieved by SKS. Needless to say, the untapped potential for microfi nance is huge in most of Africa too.

Th e governance model of these MFIs varies. VBSP is state owned, Grameen is a for-profi t bank, BRAC and ASA are not-for-profi ts and SKS is a for-profi t non-bank fi nancial company.

Figure 1. Outreach based on data from MIX.

2 http://mixmarket.org.

Co-Creation for Impact Investment in Microfinance 73


A comparison of the profi tability of these fi ve institu-tions in Figure 2 indicates that the highest return on assets of 12% is provided by ASA which is a not-for-profi t. Th e state owned bank, VBSP is not breaking even on its microfi nance operations. Th e average return on assets (ROA) of the other three MFIs varies from 1% to 4%. Th eir average return on equity (ROE) is much higher owing to the impact of leverage and varies from 11% to 13%, with ASA again as an outlier at 22% average, but it is coming into the normal range, perhaps owing to satura-tion and increased competition.

Th e boom of microfi nance and its high profi ts was brought to the attention of commercial investors by initial public off erings made by Compartamos in Mexico in 2007 (Rosenberg, 2007) and SKS in India in 2010 (Chen et al., 2010). Both initial public off erings were oversub-scribed 13 times. Th e attraction of the sector to commer-cial as well as social investors was due to these high growth rates and potentially high profi tability coupled by a chance to do good to millions of families.

Indeed, for many years, most of the private invest-ment capital was limited to the top 150 to 200 tier 1 MFIs (Gokhale, 2009) and most of it in the form of loans. An example of venture capital providing equity fi nancing is SKS. In 2005, after SKS started making profi ts and con-

verted itself from a not-for-profi t society to a for-profi t non-bank fi nancial company, venture capital and private equity started trickling in, as shown in Exhibit 1.

Th e next question is what can be done to attract private equity to smaller MFIs and greenfi led MFIs to help them scale up? Some private equity is therefore searching for such profi table MFIs. However, now there is evidence that many of the tier 2 companies do become profi table with time and scale, if they are well governed. Th e problem with tier 3 and tier 4 funds is like that of

Figure 2. ROA and ROE based on data from MIX.

Exhibit 1. Private equity fuels growth of SKS

2006 First round of equity totaling US$1.6 million from Unitus, the Small Industries Development Bank of India (SIDBI), Vinod Khosla, and Ravi Reddy.

2007 SKS closed a second round of equity fi nancing totaling US$12 million led by Sequoia.

2008 US$37 million in a third round, mainly raised from existing shareholders, including another US$4.7 million from Sequoia.

2009 Fourth funding round, US$75 million led by Sandstone Capital.

Source: Chen et al. (2010).

74 Arvind Ashta


the poor borrower: ‘nobody gives the small MFI the fi rst ten thousand dollars’. Can social capital help them?

Venture capital can seize the opportunityIf it can be seen that many of these tier 3 MFIs will be young turks who will move up quickly to tier 2 and even-tually to tier 1, then patient venture capital could be attracted. Indeed, a host of private equity and venture capital funds are coming up to invest in this sector to serve tier 2 and tier 3 MFIs. To understand why, it is best to resume how private equity works.

In general, the fi rst consideration of these funds is to fi nd mispriced fi rms and to buy cheap, add value and sell out. To do this, they invariably select high growth indus-tries (Zider, 1998). Th ey leverage debt, focus on cash fl ows and not on earnings, they reduce costs, they focus on core businesses where the target can outperform its rivals and they have a good exit strategy (Kiechel III, 2007). In addition, they usually align managers’ incen-tives and make quick decisions since they are privately owned (Barber and Goold, 2007). In recent years, the guidance role of nurturing the small business to scale is being stressed (Ghalbouni and Rouziès, 2010).

Within this private equity off ering, most venture capital, including state sponsored venture capital, focus exclusively on economic returns such as profi ts and employment, but some focus on social returns either for correctional purposes or for additional impact (Rubin, 2009). However, Rubin’s classifi cation based on the Amer-ican experience, does not account for the fact that some funds may be focused both on targeting geographies and reducing poverty, even if in her overall classifi cation, com-munity development funds fi t into both categories, but within this category of funds she separates the funds which have diff erent objectives.

To fi ll this international gap for funds, to make a geographic correction and to reduce poverty while making profi ts, a new segment consists of impact investors who are either socially responsible investors (expecting near commercial returns but in desired sectors) or social inves-

tors (wanting a social or environmental impact, with some low rate of return to cover infl ation). Th ese latter are being termed impact investors. According to the Monitor Insti-tute, impact investors can be defi ned as ‘investors who actively place capital in businesses and funds that generate social and/or environmental good and at least return nominal principal to the investor.’ Impact investors are a wide ranging set of investors that include foundations, faith-based investors, mainstream fi nancial institutions, pension and mutual funds, insurance companies, double and triple bottom-line venture capital and private equity funds, family offi ces and high net worth individuals, reg-istered investment advisors and certifi ed fi nancial plan-ners. Today, several national and international organizations of impact investors exist including the Global Impact Investor Network, Investor’s Circle, ANDES, Social Venture Network and the Slow Money Movement.3 Essentially, these investors are providing bridging capital rather than bonding capital (Knorringa and van Staveren, 2007; Schuller, 2007).

What does this mean for microfi nance? First, since microfi nance sector is growing at an average rate of 30% per year (10% even during the economic crisis), private equity funds in general and venture capital funds in par-ticular would like to enter this segment. In fact, a host of investors are indeed entering the microfi nance market, including such impact investors. Goodman (2006) has indicated that these include private donors, development agencies, private individuals, private investment funds and institutional investors including investment funds. Th e microfi nance investment funds include commercial, quasi-commercial and development funds. Th e latter seek a social return while maintaining the real infl ation-adjusted value of their equity (Goodman, 2006). Th ese funds are provid-ing social capital in the sense of Robison et al. (2002, p. 19):

Social capital is a person’s or group’s sympathy toward another person or group that may produce a potential

3 http://missionmarkets.com/services/investor-services/.



benefi t, advantage, and preferential treatment for another person or group of persons beyond that expected in an exchange relationship.

Th ese development funds could be considered to be impact investors. However, there is place in the market for all kinds of investors: commercial investors to fuel the growth of the commercial microfi nance sector and social investors and donors to reach the MFIs who are lending to the poorest of the poor (Cull et al., 2009).

Th eir main questions which now need to be addressed are:

• Selection: In which MFIs should they invest, out of the 10,000 exiting MFIs, spread over 160 countries with diff erent regulations, notably on foreign ownership and dividend repatriation?

• Governance: How are these MFIs governed?• How will this MFI scale its business and profi ts?• Will the private equity manager be able to provide the

right technical guidance?

The venture capital impact strategy for microfinanceTh e selection of MFIs requires partnering with a fi rm which already knows the local microfi nance sector well and can diligence investments in order to direct the funds to well governed MFIs in stable markets. Good invest-ment advisors can help the fund manager avoid over-saturated markets4 and also focus on markets where macro-economic and political situation is stable with good regulation and transparency requirements.5 Th is already lowers the risk of the investment fund.

Th e subsequent question, then, is how to ensure that the selected companies grow. Evidently, in this age of

dynamic inter-connectivity, any business off er becomes competitive if it uses the strengths of a large number of complimentary actors to get together to provide a rich experience to the fi nal consumer or to the business manager. Th is trend has been accompanied by a parallel focus on social responsibility shifting from the corporate to either the wider network or to the individual (Ashta, 2009). Th is evolution from the corporate to the network can be seen to start with a shift in focus from economic action to social action (Freeman and Reed, 1983), fol-lowed by a focus which was no longer on the fi rm which was just a connected network of individuals (Freeman and Liedtka, 1991). Th ereafter, the concept of Value Added Communities was introduced (Means and Schneider, 2000): fi rms were expected to become small, low capital-ized, brand focused, with high fl exibility and operating in online exchange networks. A few years later, the Value Based Network concept indicated the responsibility that all fi rms in the network should gain (Wheeler et al., 2003). Th e focus was not just on fi rms but on all inter-connected systems (Stormer, 2003). Figure 3 captures this discussion and brings out the networked relationships between fi rms aiming at creating value and sharing it.

Th erefore, following this reasoning, to create value for investors, a group of organizations needs to come together

4 Microfi nance Focus, June 9, 2011: Interview: ‘We avoid investing in saturated microfi nance markets’ — Vision Microfi nance.5 Microfi nance Focus, July 8, 2011: ‘Microfi nance markets with good regulatory frameworks preferred’ — Ambers & Co. Figure 3. Firms as networks as part of networks.

76 Arvind Ashta


to ensure that investors’ money is going to the right MFIs and that the MFI would get the necessary advice to sus-tainably scale its operations.

To all this, a concept of co-creation was introduced by C. K. Prahalad and Venkat Ramaswamy (2003, 2004a, 2004b) where the customer is helping the producer to enrich his experience and creating value for the entire network using the product. An example of co-creation is open source software. By trying it out and reporting bugs, the customer is permitting software engineers to improve the program for his better enjoyment and those of all the other existing customers. Another example is online social media such as Facebook. Every time a person tags or com-ments on a photograph, the value of the content improves for all the users and improves the value and valuation of Facebook. Within the microfi nance world, online lending sites such as Babyloan, Kiva and RangDe use information from their customers (MFIs) on their customers (poor entrepreneurs) to attract money from social investors and provide this money at lower rates to the MFIs.

Finally, getting back to microfi nance basics, the way a successful MFI operates is simple. It experiments diff er-ent lending models in diff erent villages. Once it discovers a successful model, which could be a particular type of group lending or individual lending with diff erent incen-tives, it abandons all the others and uses this standardized model to scale up. Th is standardization is essential for cost reduction and eventual fi nancial sustainability so that all the employees are off ering standard size loans to custom-ers and ensuring that loan repayment and interest pay-ments are round numbers so that there is no time wasted in counting the money and returning change. Initially, the MFI may record all this on manual ledgers or, if it has access to a computer, on spreadsheets such as Excel. However, if each employee is handling a portfolio of 200 customers with short loans of four to six months, it is evident that the system needs computerized management information systems (MISs) for the employee to know each morning which customers in which village need to repay. In fact such computerized systems are essential to

cost management in an industry where operational costs are high due to the low average loan size (Kunigahalli, 2011). Once computerized, the information system can also produce a number of diff erent information reports required by management, donors, investors and other stakeholders (Nyapati, 2011) and today there are over a hundred MIS software dedicated to microfi nance opera-tions. Cost-cutting, especially in times of crisis, is now driving managers to search for the most cost-eff ective software including free and open-source solutions, but such free solutions impose other transaction costs such as hiring specialized people who can adapt them to the fi rm (Augsburg et al., 2011; Das, 2011). Th is adaptation is crucial because diff erent kinds of MFIs have diff erent needs and one size does not suit all (Khan, 2011), for example rural MFIs may have specifi c implementation problems (Iyengar et al., 2010; Musa and Khan, 2010). As a result, an MFI needs appropriate dedicated MISs for its needs.

Th erefore, in today’s worId, increasing the profi ts of the MFI requires better management, new delivery channels, new products and an interaction with a multitude of actors who work with the MFI to improve its profi t. Th e single most important technology for scaling is considered to be good MISs. Th e single most important delivery channel for the poor is using mobile telephone for payments. Th e new products for microfi nance are micro-insurance and micro-transfers of money. Any investment fund manager who wants to invest in this sector needs the capacity to bring together a team of technical advisors to simultaneously provide these diff erent inputs to the MFI and transform it from a 10,000 client single-product company to a 100,000 client, multiple product, multiple channel company. Th e MFI, is of course the interested party and a willing partner to co-create this value. To the extent possible, the MFI would also like its own customer, the poor entrepreneur to co-create value for itself by providing information required for distributing some of these products like life insurance and reducing the asymmetric information are hence reduc-ing the costs of these services.



Riskebiz: a networked impact investorOne fund who understands all this is Riskebiz which just launched its fundraising in February 2011 (Ashta, 2011b) and raised $257,000 in March from the Michael O’Brian Family Foundation. Before this launch, it brought together a team of players who have the technology and the interest to develop the market for the poor. Figure 4 shows how the team of players will co-create value for the poor, for the MFIs and, eventually, for the investors. Th e dashed arrows indicate movement of funds, the thin arrows indicate information fl ow between partners and the

thick arrows indicate impact on the system from the partners.

Riskebiz has partnered with Planis (on February 2, 2010), who is now merging with ResponsAbility, and who knows the microfi nance sector very well, being associated with the PlaNet fi nance group, who are probably the second largest private multi-service provider to the micro-fi nance sector. PlaNIS has been able to link private and institutional fi nancial market players to the local microfi -nance sector. It aims at meeting the growing needs of developing and promising MFIs, providing them with

Figure 4. Riskebiz: an impact co-creation investment model.

78 Arvind Ashta


tools usually used by and reserved to other markets. PlaNIS can be viewed as a bridge between international funds and MFIs. Its major fi elds of expertise include sourcing promising and leading MFIs by geographical area; providing a high quality investment and credit risk analysis leading to professional advice; and monitoring investments through adequate fi nancial tools. PlaNIS’ projects include the development of structured fi nancing activities through the syndication or arrangement of man-dates and through more sophisticated structured transac-tions, such as collateralized loan obligations. PlaNis will help Riskebiz select the right institutions as well as monitor their performance.6

To help the MFI scale up, to increase its effi ciency and to reduce cost, attention is being focused on Software-as-a-Service (SaaS) (Ashta and Patel, 2010). Th is is a model where one software solution is hosted online and provided to MFIs on a pay-as-you-go basis. Th is removes the burden of MISs and hardware management from the MFI and increases external trust and transparency into the MFI. Riskebiz has selected Mambu as the online software appli-cation for its microfi nance organizations. It is an easy way for organizations to manage their portfolio and enable their growth and success in providing fi nancial services to the poor. Th e MFIs will access the Mambu software on the internet using a web browser. Each MFI will have a private, secure login access with all their information which they can access and extract at anytime. MFIs will not need to install anything or manage the technology behind the application. Th ey do not need to worry about maintenance, backups, server hardware, databases, secu-rity or upgrades; the only thing MFIs require is an internet connection. Th e use of this information system by the MFIs could off er investors real-time access to reports.

Mambu indicates that using the SaaS model is a fi rst for the MFI sector, which means greater transparency, quicker sharing of information and ability to react quicker to any changes within the MFI market. Th e use of this MIS co-creates value for the investment fund investing in the MFI as well as to Mambu who would gain from all the bugs reported and fi xed.

Th e use of the mobile payment delivery channel will be facilitated by Riskebiz’s partner, Kopo Kopo, who will provide the software link between MFIs and the telephone operator, also on a SaaS basis. Kopo Kopo facilitates the expansion of mobile fi nancial services to the ‘last mile’. Th ey leverage leading internet and mobile technology to lower institutional barriers to entry, increase effi ciencies, and empower both the MFI’s customers and the people they serve. Kopo Kopo off ers a software-as-a-service plat-form that enables MFIs to easily integrate their enterprise software with one or multiple mobile money systems. Th e service is available on a tiered subscription basis and allows enterprises to access the functionality they need without paying licensing, installation, and professional services fees to software vendors. If mobile phone savvy consumers are able to enter their own profi les for use on social lending websites like Babloan, Kiva or RangDe, operating costs of MFIs who are spending time uploading this information would be reduced. As a result, the end-consumer would have co-created value for the MFIs, the online lending websites, and retail social investors looking for a direct human link to the poor. Th ese advantages would be cap-tured by the investment fund.

Several micro-insurance products are being developed by Avana, which will be off ered by Riskebiz’s MFIs to their customers, thereby reducing risk in the MFIs’ loan port-folios, diversifying their revenue bases, and enhancing their social impact within the community. Avana micro-insurance is a social enterprise that seeks to expand access to insurance among the world’s poor by developing and managing aff ordable, demand-driven products to low income clients using risk capital of established insurance and re-insurance companies.

6 Other funds also take the help of microfi nance advisors for selecting MFIs: for example VisionFund takes the help of Symbiotics, see Microfi nance Focus (June 9, 2011, Interview: ‘We avoid investing in saturated microfi nance markets’ — Vision Microfi nance, available at http://www.microfi nancefocus.com/interview-’we-avoid-investing-saturated-microfi nance-markets’-vision-microfi nance.



To make this micro-insurance less risky, the health of the poor will be checked and monitored by advanced technology developed by Fio Corporation. Fio is converg-ing smartphone technology, biotechnology, and nano-technology to create portable, digital diagnostics for infectious diseases at point of care in developed and devel-oping countries alike. Designed to work with a droplet of blood and to be operated by minimally trained users in a broad range of minimal infrastructure settings, this tech-nology supports a novel business model capable of altering how the world manages its leading cause of death, disease, and economic disruption. Fio successfully demonstrated its prototype in December, 2010 and began initial fi eld tests in early 2011. Th e constant checks may help raise health consciousness and increase the productivity of these micro-entrepreneurs and reduce the risk of the MFI. Th us, in sharing information on their own health, the poor may enable a profi table and sustainable micro-insurance industry.

Riskebiz is aiming at tier 2 or tier 3 MFIs with a loan portfolio of less than $500,000. Since average loan sizes vary with the region, this could vary from 50,000 borrow-ers in South Asia to 5000 borrowers in Latin America.

ConclusionTh e paper has reviewed the strategy literature and argued that a multi-pronged strategy of a network of actors is required to interact with the customer to create competitive advantage for the participants in the network. Th e customer needs to be involved to co-create value. Th is strategy is required in the developing world to create impact on the poor, while making some profi ts for the investors.

A case study from the microfi nance sector has been presented to show that impact investors understand this and that venture capital funds are partnering with appro-priate partners to create a multi-pronged strategy that will lead to co-creation of value by combining fi nance and technology to enable the poor to get out of poverty. ‘It is about lowering risk and increasing business,’ says Kevin

Day, the president of Riskebiz. So far, the strategy seems to be working because the fund has already managed to obtain funds.

Th e interest of venture capital fi rms to invest in devel-oping markets emerges from the fast growth taking place there, while the fi nancial crisis has indicated the limits to growth in developed parts of the world. At the same time, donor-investors are attracted by the microfi nance sector because serving the poor no longer represents a Danaid’s bucket of unending donations but creates responsible bor-rowing and may even provide a return on their investment at a time when investments in the developed world are not so profi table. Th us, even a total loss on such invest-ments can still be viewed as a CSR initiative, while any positive return would convert this into a social business.

Perhaps, the argument developed in this paper, co-creation for impact investment in MFIs needs to be extended to such co-created impact investment in micro-enterprises. Th ese micro-enterprises, in the microfi nance context, are using a mix of personal savings and micro-credit loans. Th ere is perhaps a need for business angels and venture capital funds of very small amounts to supple-ment the fi nancing of these small enterprises. Th is is one avenue for future research and future development of this sector.

To some extent, technology has enabled online fi nanc-ers like Kiva, Babyloan, Rangde and DhanaX to enable retail fi nancing of MFIs (Ashta and Assadi, 2010; Johnson et al., 2010) and more recently organization like Kick-starter are enabling certain sectors to use innovative dona-tion schemes for creative micro-enterprise, However, venture capital and business angel fi nance using technol-ogy still needs to be developed further.

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BIOGRAPHICAL NOTE

Arvind Ashta holds the Banque Populaire Chair in Microfi nance of the Burgundy School of Business (Groupe ESC Dijon-Bourgogne) and is associated with the Center for European Research in Microfi nance (CERMi). Besides fi nance, control and law, he off ers courses in microfi nance and researches regulatory aspects of microfi nance and advanced technology in microfi nance. He has taught microfi nance while visiting faculties in Chicago (US), Pforzheim (Germany) and Brussels (Belgium). He has a number of publications in international journals. He has recently edited a book on Advanced Technologies for Microfi nance and has guest edited two special editions of the Journal of Electronic Commerce in Organizations devoted to microfi nance and new technologies.

Correspondence to:Arvind AshtaBurgundy School of Business7 rue Nicolas Fetu21000 Dijon, Francee-mail: [email protected]

co-creation for impact investment in microfinance

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