Montevideo, 14 February 2011

Strategic Alternatives for South American microfinance institutions.- Second European Research conference on Microfinance (16-18 June 2011) Abstract .- As the title suggest, this paper is about the strategic paths South American Microfinance institutions (MFIs) can follow, as alternative to the more traditional “upgrading” or “downscalling”. Generally, it has been accepted that strategic theory, written mostly for commercial organizations, can be used in other businesses, like not for profit. That may be so, but there are some ideas that may not work as properly in this new area, as they worked in the other. Undoubtedly MFIs have some particularities, for instance NGO-kind are not worried about making money, but they do worry about taking people out of poverty. Something similar can be said about banks getting into microfinance, although they do want to make money in this new arena, they find that there are specific things which they cannot deal the same way they have done up to now. ¿What´s happening and what can be suggested? As said at the beginning, there are two strategies very often used in South American MFIs, one is called “upgrading” (basically an NGO becoming a bank), the other one is “downscalling” (basically a traditional bank opening a strictly microfinance office). Are there other possibilities? Yes there are, strategic theory suggests others. These possibilities are important for various reasons: a) they come from strategic analysis; b) they can be useful for both banks and NGO kind MFI and c) they mix South American reality concerning MFI with strategic theory. The paper to be presented is then about the new alternatives the MFIs in the region have. These issues are discussed and analyzed, both on where they come from and also on their benefits and problems. One of them is to create strategic alliances between banks and NGOs, where the first do their social work and then “pass” the clients potentially good to the banks. As it can be seen it is a way of taking the maximum out of the strengths of each institution. To finish, it is important to quote that the paper follows the one presented in the first conference organized by CERMI in Brussels in 2009.

A.- Introduction Strategic theory was written at its beginning for commercial organizations (Ansoff 1988, preface), afterwards it became a useful tool in other types of organizations such as NGOs1. Microfinance institutions can be put in this “box”; having in mind that they have many particularities. For instance, NGOs are always depending on donors, while MFIs2, due to the kind of business they deal with, can be self sufficient. So, it is interesting to see if strategic theory says something important on this matter. If it could be helpful, then MFIs would be more efficient and by doing so, could help more people. But before getting into the problem, an important division must be established. There are several kinds of MFIs, ONGs, Village banks, cooperatives, commercial, state owned, private and may be more. All of them can be classified in two groups, for profit or non for profit. This division is important for management and strategic reasons: for profit organizations are more easily managed than not for profit ones. Concerning strategy development, not for profit organizations have certain particularities: ideology and culture are strong, funding does not come from clients but from donors, influence from outside is then bigger (Johnson, Scholes y Whittington 2006, page 279). Anyway, there is something that the two kinds of organizations have in common. Both groups share a particular kind of client, generally poor or near poor ones. The technical literature suggests that poorer clients and/or female are welcomed by NGOs while commercial IMFs have better off client (Lensink and Mersland 2009). Up to now, both kind of organizations have been growing (Navajas y Tejerina 2006), in part because there is a huge market of poor people that needs financing, in part because these “banks” have been doing well, not as previous tries, notably rural banks in the sixties. Several authors have analyzed the poor results of subsidized rural banks (De Briey 2005, Gutiérrez Nieto 2005, Adams and Von Pischke 1992) in order to avoid their pitfalls. And how have they been growing? According to technical literature, NGO-kind institutions get into the financial world becoming regulated by central banks and changing their legal status, in a move known as “upgrading”; and banks get into poorer segments in a move known as “downscalling”. That move is going on, although it has some perils, as all changes have. It can even be said that most change efforts in all kinds of organizations are unsuccessful rather than successful (Kotter 1995). Anyway, going back to the ideas of “downscaling” and “upgrading”, both moves make the organizations get into a business that is not theirs. As it can be expected, not all the organizations have succeeded in this move. So, this work tries to open, using purely strategic thinking and technical literature, new roads for MFIs 1 Non-governmental Institutions

2 Microfinance Institutions.

B.- Some important practical and theoretic previous considerations.- 1.- Ansoff Matrix.- One important development from strategic literature belongs to Igor Ansoff, who stated back in the sixties that companies pretending to grow can follow two main ways. That idea became famous later and was known as the product – market matrix (Concari 2009). The scheme can be seen in fig. 1. FIG. 1.-

According to it, there are two ways to grow or growth vectors (Ansoff 1988, pages 83 and following). One is to make innovations in market, the other one is to create new products. The matrix is the combination of these two axis. Examples that follow this idea can be found in the South American market (Concari 2009). For example, microcredit for housing is a product development while the Corposol/Finansol experience in Colombia, although not successful, was a case of diversification (ibidem).

2.- Porter´s Value chain.- Michael Porter (1985), a very important modern strategy author, proposed to analyze the company´s activities as a chain (see Fig. 2). Each link in this particular chain is an activity the organization does. As it can be seen, there are two main groups in this scheme: primary and support. The first ones are basic, like for an airline to fly a plane. The support one´s are the ones that allow the others to work. For instance, I&R activities may not be important today for the company, but no doubt they´ll be tomorrow if they want to introduce new services or products. That´s why they are “support activities”. So, this representation is useful because it shows quite quickly what a company does. Also, it represents the costs involved in the transactions inside it. The full length of the chain is a representation of the 100% of the product´s (or service) price (Johnson, Scholes y Whittington 2006, page 136). FIG. 2.-

Going one step further, as it is shown in Fig 2, the final link of the chain is the margin. Applying the concept to NGOs, it can be seen that this link would not exist. That can be seen as a simple explanation why NGOs are the organizations suitable for microfinance activities with low income people. As it was shown, assuming the other activities remain equal3, an NGO is “cheaper” to run than a for profit company.

3 This is a strong hypothesis

3.- NGOs and for profit market.- Another important consideration for this work; is the difference between the markets NGO serve and the ones commercial banks serve. Several authors: Maes and Foose 2006, Halder 2003 state that NGO kind MFIs have poorer clients than banks. That is easy to understand. In general, MFIs began in the microfinance job in order to help poor people to create jobs for themselves and thus improve their economic situation. On the contrary, banks began their work with people that were not poor. Before the Grameen experience, it was believed that persons in bad economic situations did not need bank services, M. Yunus proved it shouldn´t be that way, poor people pay their debts and need banking services (Yunus 2002). The most common strategy for the NGO willing to serve richer clients (or whose old clients are richer) is called “upgrading” (basically an NGO becoming a bank). The other one, followed by banks getting into microfinance is known as “downscalling” (basically a traditional bank opening a strictly microfinance office). Both moves are quite common in the South American market and several authors signal this. Concerning upgrading: CGAP 2008, Berger et al 2006, Seibel 1997. Concerning downscalling: Marulanda 2006, Seibel 1997, Berger et al 2006, Westley 2006 y 2007. 4.- Strategic Alliances.- In general, organizations have certain resources (know how, assets, money or other) (Johnson, Scholes y Whittington 2006, page 349); something that allows them to compete successfully. As times goes by, things get difficult or just change so many times, different companies decide to associate with others to cope with these new challenges (ibidem). Other possibilities for this “move” are when organizations want to improve their situation or get into a new market. In order to diminish the risks; they associate with other companies that have different resources useful for them. That move is known as “strategic alliances”. An example could be a bank with money to invest that wants to get into the microfinance market. Being a market with certain particularities, it would be useful for it have a partner that knows better about these (Johnson, Scholes and Whittington page 151). That could be the case of a NGO needing funding to go on with its work. Some time the idea described is called “joint venture”, being basically the same thing (ibidem).

5.- Linking ideas.- All the previous strategy developments have a link. The market development axis is the one both organizations share, with the difference that one works looking for a “better of” client (that´s the case of the bank); while the NGO looks for poorer clients. The idea is to match these growth vectors so that all the people involved both inside the organizations and outside them (the clients either real or potential) have something to win in the proposal.

C.- The adapted matrix.-

c.1.- two matrixes together.-

Let´s imagine two matrixes like the one in fig 1, side by side. One would be the

NGO microfinance organization, the other one the Bank microfinance

organization. Let´s assume that the market axis is the one they share, being

both a “commercial” representation, (that is to say seen as market); and a

“socio-economic” representation (the scale of wealth the clients or potential

clients have).

The other axis remaining unchanged, the result can be seen in fig 2, below.

FIG. 3.-

c.2.- The product – market NGO matrix side adapted.-

Some other changes can be explained and done. First one is the following;

although not necessary so, the poverty line could be taken as the frontier

between the markets each kind of organization has or works with.

Second, there is still one thing that does not match. Assuming that both kinds of

organizations begin with slightly different socioeconomic clients (Dichter 1996;

Mersland and Lensink 2009) their growth aims at different populations. While it

is preferable that NGO work on the poorer population due to their effectiveness

in this segment (Gutiérrez Nieto et al 2009); banks do better with richer clients.

They prefer them for commercial and other reasons. So, if the hypothesis

signaled before is accepted, it would be preferable that the growth vector of

each organization has opposite directions: one specializes in poorer clients, the

other one the contrary. The frontier, just for explanation purposes, could be

assumed to be the poverty line.

These changes lead us to figure 4.

FIG. 4.-

c.3.- The product – market bank matrix side adapted.-

Finally, we arrive to the change in the bank side of this new matrix. Banks

getting into microfinance “downscale”, that is to say, they come from the “upper”

side of the market. So, they also follow a “pro poor” policy, but coming from a

richer level.

This final step can be seen in figure 5, below.

FIG. 5.-

D.- Explaining how the adapted matrix works.-

Assuming that the microfinance aim of the organizations involved is to make

banking services available for everyone, then both bank and NGO share a

common goal. Both have a difference between why they want so for: the bank

may be willing to earn money; the NGO kind organization may be willing to get

poor clients out of poverty4.

4 Lensink and Mersland coined the “microfinance plus” concept, signifying that certain MFIs offer more

than just credit. Most of the MFIs of this group are NGOs (Lensink and Mersland 2009).

So, whether they are in the microfinance business for humanitarian reasons

(“welfarist” approach) or for profit matters (“institutionist” approach); they can

work together on the basis that each of them has something the other

organization needs and that each of them aims to a different market. There is a

lengthy literature about the differences of the “social driven” and “commercial

driven” MFIs and their different goals and efficiency achieving them: (Lensink y

Mersland 2009, Gutiérrez Nieto et al 2009, Gutiérrez Nieto et al 2007). Yet, an

important question can be asked: why looking for differences and not

similarities?

For instance, poor people do not generally know how banks work, although it

may sound easy it is not so for them. Also, their need for credit is for small

amounts; both tasks fit perfectly with what a NGO can do.

On the contrary, banks are rather bureaucratic organizations that are used to

clients they know or about whom they have information, that are used to filling

forms and the like and that need medium or big amounts of money. These

characteristics are barely the ones poor clients can have, although no doubt

they can acquire them.

The rest can be easily been imagined. ONGs could look for poor clients, help them in their initial steps towards microcredit and associated things (entrepreneurship) and once these clients have a good record of payment and need bigger sums of money, they can be “passed” to banks. The matrix exhibited in fig. 5 shows that both organizations have the same direction, but come from different levels or economic wealth. By doing so, they avoid a fight for the same market. Why these proposals can be useful? At present, the technical literature signals that while ONG “upgrade”, banks “downscale”. The result can be no other than a collision between them, in a fight for the same market. Instead, this theoretic work aims at adding the forces of each organization. However, there is an important point remaining. On what basis would an ONG and a bank work together if they are basically competitors in the microfinance business? First, although in the same business, they have different segments of the market. Also, it can be assumed they have different cultures; one is a “non profit”, the other the contrary. So the NGO could “capture” below poverty line clients, introduce them to microfinance activities, and if they become good entrepreneurs, “pass” them to the bank. Why is that so? If, as said before in this paper, NGO do better with people with low income, then why should they “upgrade” and move away from what they do best? However, one problem these types of organizations have is their financing. If they are able to transform poor clients into successful entrepreneurs, then they could receive money from the bank to which they “pass” this client.

And the bank?; what does it give and what does it win?. On the basis that banks are organizations that have money to invest but are rather risk-avoiders; then working in this way they would receive a client rather trustworthy. The NGO or a credit bureau could have his record (“credit bureaus” are used in microfinance- Buchenau 2003). So, why would it have to downscale and deal with a particular segment it does not know how to manage properly if it can invest on something similar, well known and less risky? So, this model of strategic thinking has many advantages. It asks from each organization participating what it makes best. It also permits the microfinance system to go on helping low income people improve their condition. Finally it breaks with the classical upgrading-downscaling growth structure. E.- Model limitations.-

As any theoretical construction, the work has limitations. The ones perceived at

this moment are the following:

1. Cultural reasons: strategic alliances between different organizations may

not work because of the differences between the cultures of each (Moss

Kanter 1994). That can happen for many reasons, sometimes middle

managers are not as broad minded as general managers (ibidem),

sometimes the companies have different cultures themselves (for profit

and not for profit for instance).

2. Lack of commitment with the new idea. That is to say, if two companies

share are responsible for a new one, they must believe and work towards

the success of it. An example of this can be seen in the bolivian “Eco

futuro” case, a merger between five MFIs that failed (McCarter 2002).

3. Banking regulations. The banking business is a highly regulated one;

probably because of it is importance. Thus, although it may be easy to

talk about making arrangements between organizations belonging to this

sector, regulations may make it difficult. For instance, MFIs ONG kind

cannot collect savings from clients precisely for regulatory reasons.

(Almagro y Fiestas 2003). In the case of alliances or of selling of clients,

probably different countries may have regulations.

4. The main change on the traditional 2x2 product market - matrix is in the

market axis. The new 4x2 matrix should also represent new ideas for the

axis representing product.

F.- Conclusions.-

1. This paper is just about the usefulness of strategy for microfinance

organizations. The hypothesis behind it is that the microfinance business

has achieved a certain degree of development that makes possible to

use strategic theory. Following this idea, then many tools that work

properly in for profit companies could be successful in MFIs.

2. As any plan, it is useful not just if it is done but also because it makes

people involved in the matter; think about the alternatives, pros and cons

of what they are willing to do. The meaning of this is that the work of

thinking on a plan is useful in itself. That is so because it makes

managers think in other possibilities, not just in what is happening.

Perhaps the clearest example of that can be seen in scenario planning

(Van der Heijden 2005). This can be seen in other words used to

describe the task of the manager: “strategizing”, “learning” and

“integrating perception, thinking and action” (ibidem page 53).

3. Strategy is also about taking the best of each organization (Johnson,

Scholes and Whittington, pages 116 and following). In the proposed

model, each IMF participating on the alliance does what it knows: ONG

kind help poorer clients, bank work with richer ones. Both share they

commitment towards each one´s goal: defeating poverty (ONG) and

making banking services available for poor people (bank). By sharing

they respective goal, they achieve a higher purpose: defeating poverty.

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