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October 23, 2020

Why we invested in a Supply Chain Financing company

This is the first in a series of blog posts by Sohil Shah, from our investment team, about Gojo's investment thesis and why we chose each of our partner companies.

The founding members of Loan Frame Technologies (from left to right): Rishi Arya, Shailesh Jacob, and Akshun Gulati

There are more than 63 million Micro, Small and Medium Enterprises (MSME) in India1. That is a huge number. They contribute to 30% of India’s GDP. That is significant. They employ over 100 million people. That is impactful. 

Of the 63 million MSMEs, 99.4% are micro enterprises. These are the ones that you regularly encounter in your daily life. From the ubiquitous kirana (grocery) stores, to hardware stores, stationery shops, recharge and remittance shops, they are all around us.

But did you ever wonder why these businesses often struggle and remain small, with a lot of them ultimately shutting down? Certain credible researchers in the country point to “lack of access to finance” as the single largest problem plaguing the MSME industry. It is estimated that the current unmet credit gap is roughly USD 300 billion, and is expected to increase to USD 900 billion by 2022. On further investigation, it wasn’t difficult to see that in reality, a lot of MSMEs remain excluded from the formal financial system. This gave us our next investment objective!

When we started looking at the MSME financing space, one sub-sector that stood out was Supply Chain Finance (SCF). Truth be told, SCF has been around in various forms for a long time. The most traditional forms of SCF have been trade financing and factoring, which are largely dominated by large or international banks on one side and mid-to-large corporates on the other. Moreover, banks have traditionally preferred offering simple working capital loans over supply chain financing due to lack of borrower data and difficulty in assessing the collateral provided. Until very recently, this created a large vacuum in the space.

The following diagram illustrates how Supply Chain Finance (SCF) works:

The advent of fintechs has revolutionized the SCF segment. From running analytics on transaction or trade data to providing app- or platform-based financing, technology is set to make the SCF process more efficient, flexible and transparent. With technology, lenders can now provide financing to the MSMEs further down the value chain. SCF can enable MSME suppliers, distributors and retailers to increase their working capital by availing low cost and flexible credit, which in turn opens up new business or expansion opportunities. At the same time, it also helps corporates to improve their working capital management and enables lenders to assess, measure, and manage the risks of extending financing to MSMEs more effectively.

On further investigation, there were some aspects of SCF that we really liked:

  1. Hugely underpenetrated market: Around 90% of anchor/corporates do not have a supply chain finance program for their distributors / retailers, representing a ~USD 100 billion lending opportunity
  2. Limited delinquency: The closed-loop financing built on a strong relationship between a corporate and its distributors/retailers helps in keeping delinquencies low 
  3. Limited end-use prevents diversion of funds: The biggest reason for defaults in MSMEs is lack of financial discipline. MSMEs borrow citing business reasons, but may divert funds for personal / lifestyle needs. In SCF, the payment is made directly to the Anchor, restricting the end use to financing MSME working capital, further minimizing defaults
  4. Repeat business and data: Lending is done on the basis of invoices raised by the anchor/corporate. The inherent nature of this product creates borrower stickiness and allows large-scale collection of data on distributors and retailers which eventually helps in determining market trends and managing sectoral disruptions and risks

Loan Frame Technologies, our most recent investment, is a fintech platform working in this space. We are excited by Loan Frame’s vision of leveraging cutting-edge technologies and data to build the most sophisticated next generation micro-business lending platform in India. The team is passionate about serving under-banked micro-businesses which aligns well with Gojo’s vision of extending financial inclusion across emerging markets. 

Loan Frame’s proprietary and flexible technology platform enables short term and flexible credit to distributors, dealers and retailers associated with mid- to large-sized corporates. The company primarily focuses on distribution finance, where it provides 7-90 day pay-as-you-use working capital products. Distribution finance gives small businesses credit primarily for purchasing inventory whilst helping corporates to better manage their receivables.

Unlike a lot of fintechs who jump right into action, the team spent a couple of years understanding the real challenges that micro businesses grapple with and how technology can sustainably solve these issues. The initial phase was exclusively spent on building a top-shelf technology platform – one which integrates directly with the anchor/corporate and communicates with lender and distributor/retailer via web or app on real-time basis. 

One key thing the team realized fairly quickly is that SCF cannot succeed with a “one-size-fits-all” approach, and that’s where we believe the Company has built its moat. Loan Frame has a very nuanced approach to underwriting developed through their deep understanding of the segments where they operate. This differentiated approach has allowed the Company to assess businesses in the context of the industry where they operate, thus opening up possibilities for those MSMEs with previously limited access to credit.

Finally, Loan Frame’s composite lending model combines the benefits of both on-balance sheet lending, which provides the ability to test innovative products in new markets or segments, and off-balance sheet lending, which is highly scalable and capital efficient. This gives it an edge in comparison to traditional lenders.

By the time we decided to invest in Loan Frame, it was already on track to achieve approximately USD 100 million in disbursals and we hadn’t even scratched the surface! We believe this is a timely and well-aligned partnership to build India’s largest and most preferred tech-enabled MSME lending platform.

Sohil Shah is a member of Gojo's investment team. He leads the process of building Gojo's investment pipeline and selecting our long-term partners to further our mission of extending financial inclusion to everyone.

Published by Sohil Shah in Blog posts JP
Tags: Investment, Technology

September 30, 2020

The moment I realized the limitations of microcredit

Everyone is a product of their experience. My own experience was the original reason I believed strongly in microcredit. Personally, lending helped me get out of poverty— my parents' efforts to finance my education and scholarship programmes enabled me to enter higher education, allowing me to start my career at Morgan Stanley. 

Unlike in the natural sciences, causal relationships in society are not crystal clear. Once you develop a certain perspective, you tend to see things through its lens. My overconfidence in microcredit had remained largely unaltered even after seeing the results of randomised controlled trials (RCTs) on the impact of microcredit. My initial argument against the RCT results on microcredit was that if an MFI carefully selected its clients, microcredit could still bring about a significant impact. 

What eventually changed my view of microcredit was a series of field studies I conducted. I borrowed from the research methodology of Stuart Rutherford, one of our Directors and a renowned microfinance practitioner. The research focused on understanding how people manage their money. 

Here is how the research would go: I would randomly visit households in an area where financial service providers operate. Then I would explain to the villagers that I was conducting research on the economy of the township. (I don't like to lie, but couldn’t say that I was from a microfinance organisation, in case it distorted people's answers.) 

Then I’d ask questions in the following order. The order of the questions mattered, as if I had asked the questions about finance first, I would have been less likely to get answers that closely  reflected the reality of their lives. 

  1. Household: family members, native town, age, education, etc.
  2. Occupations: type of businesses/jobs, unit economics, etc.
  3. Assets: house, land, vehicles, etc. 
  4. Finances: ask how they deal with the excess or shortfall of the cash

The sample size was not large, but the results were strong enough to make me revisit the impact of microcredit. Somehow, the people who were borrowing loans from MFIs were less affluent (at least in terms of liquidity) than those who didn't. For example, those who had microcredit tended to have more assets, but were facing difficulty in managing their monthly cash flows, including repayments to MFIs. On the other hand, those without microcredit didn’t own many assets (and thus at face value seemed to be less affluent), but they could easily achieve positive net cash flow every month and often added to their reserves for a rainy day.

One of the people I spoke to in Cambodia, a villager who does not borrow from MFIs

On top of this, the MFIs the villagers mentioned were reputable ones in the country. I needed to face the facts sincerely. 

There are two things that could have explained this. First, it could have been that the microcredit interest rate was higher than the average return on investment of the customers. Second, it could have been that MFIs provided loans to unpromising businesses.  

The first didn’t sound plausible, because there are many good investment opportunities that can generate 100+% return on investment. For example, if you buy 100 chickens for $500, then you can generate $3000 revenue per year. After subtracting personnel costs ($1-2 per hour) and cages and feeds ($200 or so), you still have $1,000 net income. 

I became convinced that the second reason was the culprit. This is in line with the paper published by Duflo et al., titled “Can Microfinance Unlock a Poverty Trap for Some Entrepreneurs? (2019)”. Their study suggests that if microcredit is provided to those who ran the business before the funding, it does increase the income of the borrowers. 

It made sense. Business loans are meant to expand businesses, not to start entirely new ones. Most entrepreneurs around the world create their companies with their own money, and after proving the concept, they begin borrowing money to expand their businesses further. Microcredit cannot be an exception. As many other successful business owners have done, people need to test their original business hypotheses with their own reserves and scale it to a certain level before obtaining loans, despite the difficulties they might face in building initial  lump sums. 

The experience made me think hard about how we can promote savings as a tool to improve clients’ outcomes, as well as a tool to leverage the impact of microcredit. Savings are not only a reserve by which people can survive rainy days, but also serve as seed capital by which people can improve their lives. 

The challenge we are now working to solve at Gojo is how to provide useful and affordable saving services for those who don’t have smartphones, are not connected to 3G networks, are less literate, particularly in terms of digital services, and who live far away from microfinance branches. At Gojo these days, we are exploring various solutions and would love to hear from anyone with expertise in this area.

Taejun is the co-founder and CEO of Gojo. He is passionate about equality of opportunity. Prior to founding Gojo, Taejun worked in investment banking and founded Living in Peace, an NGO.

Published by Taejun Shin in Blog posts JP
Tags: Loans, Savings

September 29, 2020

Getting impact measurement for service providers off the ground: A manifesto

Over the past decade, the rise of impact investing has been accompanied by the rise of the term impact measurement. Sir Ronald Cohen, one of the most prominent pioneers of impact investing, has been particularly influential in this area. 

For investors, impact measurement makes sense and is important to do. As proponents of impact measurement say, standardised impact measures enable resources to be allocated to the most effective enterprises, and can help to grow the sector by attracting increasing numbers of socially conscious investors.

When it comes to service providers, however, I’ve found that the motivation to measure impact is often externally focused, and I think this has to do with the fact that the push for impact measurement has largely been led by investors. Many frontline service providers see impact measurement’s primary benefit as supporting marketing and fundraising, to the extent that organisations often assign the same team member to both marketing and impact measurement. Impact measurement tends to be seen as, at best, a nice-to-have, and, at worst, an expensive imposition.

Nonetheless, there are really good reasons for service providers to measure their impact— reasons that are more about building better businesses than about demonstrating results to external stakeholders. It’s simply that the prevalent framing of impact measurement isn’t helping people to see this— and impact cannot begin to be meaningfully measured without a genuine commitment from service providers.

If impact measurement is to be valued by service providers, then it needs to be framed in a way that serves their needs. I don’t think the value proposition of impact measurement for service providers ought to be about gathering sufficiently impressive numbers, or even necessarily about measuring long-term, sustained impact1, as such.What can make impact measurement truly valuable for service providers is the way it facilitates learning— learning about the people we work with and the role our services play in their lives, learning about the gaps between our assumptions and reality, and learning about how we can bring our theories of change and our actions ever closer to the reality of clients’ lives. 

I’ve found, however, that the use of impact measurement for practical learning can be hampered by the perception that service providers need to be collecting standardised, comparable data on impact (as opposed to outcomes) for the benefit of external stakeholders. This perception can encourage:

  • A bias towards measuring positive impact
  • A preference for a static set of indicators rather than a dynamic and evolving set
  • A view that impact happens so far in the future that young organisations cannot measure it, short feedback loops cannot be built around it, and that impact measurement therefore has no bearing on what an organisation does today or tomorrow

At least initially, prioritising learning in impact measurement could mean sacrificing some of the sacred cows of existing systems and frameworks, such as a focus on standardisation or on long-term, rigorously verifiable impact. It’s not that these things aren’t important— but that impact measurement which is of practical use to service providers is not high-level or long-term, but rather specific, dynamic, and of immediate relevance. 

Given enough time to bed in, an organisation might pursue all these things at once. But getting impact measurement off the ground within the limited resources of frontline service providers means prioritising usefulness, and prioritising usefulness could mean sacrificing high-level, comparable data for depth of understanding in a specific area. It might mean giving up a comprehensive, standardised set of measures in favour of a dynamic set of metrics that evolves as we learn. At least at first, it might mean focusing on more directly attributable outcomes rather than wider or longer-term impact.

For an enterprise with social goals, its degree of commitment to impact measurement can be seen as a proxy for the value it places on learning and innovation. While a commitment to learning or lack thereof might not make or break an organisation in the next six, or even twelve, months, it will ultimately be essential to the medium and long-term survival and flourishing of the organisation. 

Having encountered the above tensions and trade-offs a fair few times now, I thought it would be worth nailing my colours to the mast and sharing my rules of thumb in designing practical impact measures at Gojo, in the form of a manifesto.

I’d love to hear from colleagues in the sector about whether these ideas resonate with you.

An Impact Measurement manifesto for service providers (inspired by the Agile Manifesto)

We value:

Quality over quantity

Learning over marketing

Long-term relationship over short-term benefit

Building on existing data and processes over introducing something entirely new

Starting with small, immediate outcomes now before gathering comprehensive data on long-term impact later

While we believe in the need to balance the things on the left with the things on the right, we value the things on the left more and will put them first.

Further reading
The Social Performance Task Force’s Outcomes Working Group is doing a great job of creating practical, useful guidelines for service providers. For further reading, I’d recommend their Case for Outcomes Management and Guidelines on Outcomes Management.

Cheriel leads impact measurement at Gojo. She is currently working on implementing impact measures in Gojo's partner companies and planning a financial diaries project.

Published by Cheriel Neo in Blog posts JP
Tags: Impact measurement

September 29, 2020

Learning to innovate for impact

A customer of Microfinance Delta International (MIFIDA), Gojo’s partner company in Myanmar, who runs a small factory with several sewing machines

At Gojo, we aim to become the private sector version of the World Bank. More specifically, our mission is to extend high-quality, useful financial services to 100 million people in 50 developing countries around the world. At least 80% of our clients should be living below their national median income.1 Our services are meant to produce tangible impact in the form of financial inclusion, giving everyone, not just a few privileged people, the ability to take control of the direction of their lives. Such an ambition cannot be achieved by doing what has already been done before. We need to break new ground, discover novel angles in doing microfinance. To put it in more mundane words, we have to innovate. We're investing heavily in just that, and a key tool we are using is technology.

When it comes to doing new things with tech, Silicon Valley and startups around the world give us a well-tested (and amply written-about) framework. Simplifying greatly, this approach can be distilled into two concepts. 

The first key point is understanding the customer deeply. Listen and observe carefully. Constantly measure everything about how the product is functioning in the hands of users. That way you can be fairly confident that you're solving actual problems, rather than imaginary ones. 

Second, experiment often and fast. Product management expert Marty Cagan of Silicon Valley Product Group coined the "inconvenient truths about product": at least half of all ideas simply don't work out, and those that do work take multiple iterations to get right. Mistakes are not to be avoided but rather normalized as a useful part of a healthy creation process.

These two ideas form a powerful feedback loop for product innovation. They are at the core of popular “movements” like Lean Startup and Human-Centered Design, the power of which we believe in at Gojo. We could naively apply these lessons by the book and say that we're innovating. Unfortunately however, the Silicon Valley model on its own is not sufficient to get to where we're heading.

If we are to become the Private Sector World Bank, increased profits and growth are not enough. There's another type of "fit" here, beyond product-market fit, that we have to reach: we need to bring real change in people's lives. Selling a lot of financial products that, for instance, help clients solve temporary needs, without long-term improvements, cannot be considered a success. Even worse, there is a risk of doing harm by creating dependency and indebtedness spirals. Unlike video-game companies and social-media giants, creating addiction is definitely not something we seek.

How do we innovate around all these traps, then?

As a company, we are still new at making products. We will have a lot to learn as we go forward. However, we do already have some experience as a team and we put much thought into these problems. Our product team is already hard at work. Here is how we believe it should be done:

Work extra hard to get in the client's shoes
Because we come from very different cultures and lifestyles from our clients, it is especially important to throw away all of our assumptions and learn directly from the people we serve, in their context. All of Gojo's members, regardless of role, visit our partner companies regularly (when traveling is safe), learn from them and go with them to meet our clients. We are also blessed with the counsel of some of the most respected experts in the financial lives of the poor, such as our director Stuart Rutherford.

Own the pipeline
To be nimble with the validation of our ideas, and to keep a super-high pace of iterations, we cannot afford to depend too much on third parties when it comes to technology. Asking tech partners for permission to make even tiny changes, negotiating contracts and timelines all the time, would kill our velocity. That is why we have our own technology team with fintech and product experience, and we build the core tools and platforms ourselves. Of course, we do welcome partnerships in non-core areas, but we keep the product development and delivery pipeline firmly in our own hands.

Measure the outcomes
Numbers like app installation counts, processing times, or outstanding portfolios are only half of our KPIs. They are direct outputs, not outcomes on the lives of our clients. To see that missing half, we now have a team dedicated exclusively to impact measurement. They are now working closely with our Tech Team to build those measurements right into our solutions and make the product feedback loop truly effective.

Look at your real competition
Some other microfinance institutions provide high-quality, useful financial products that we surely want to match and surpass. But when impact is the goal, there are non-institutional players to keep in mind. For instance, often low-income households borrow from so-called informal lenders, who charge extremely high interest rates, or from wealthier relatives straining family relationships and self-esteem. Yet, these forms of borrowing are still popular even when cheaper, safer loans are available from microfinance institutions. Why do our products fail to eliminate the need for those unpleasant and risky informal debts? Clearly, it's not just the rates. Unless we treat those channels as first-class competition, we won't be able to answer such questions and change the dynamics in favor of the clients.

A group collection meeting run by an MFI in Myanmar (not MIFIDA).

While I believe that the points above may indeed help, perhaps the single most important insight that we will need to keep in mind is that large-scale success in this endeavor is more about people than it is about technology.

No one, to my knowledge, has put it better than Kentaro Toyama, professor at the University of Michigan and formerly a researcher of impactful innovation at Microsoft Research India. In his book Geek Heresy: Rescuing Social Change from the Cult of Technology, he introduced the "Law of Amplification", stating that technology merely amplifies any effects of pre-existing human intentions and abilities, whether positive or negative. Technology can't be a silver bullet; you can’t expect it to guarantee results on its own.

"Yet CIOs everywhere are asked to perform exactly that sort of wizardry. The more experienced ones are careful not to promise too much. Technology can improve systems that are already working—a kind of amplification—but it doesn’t fix systems that are broken. There is no knowledge management without management."

People, be they our clients or colleagues, will remain the drivers of our innovation. When we do finally reach the last person in the world who needs our services, perhaps somewhere in Africa or South America, it will be the fruit of the love and collaboration of humans.

Marco is part of Gojo's tech team and works on developing Gojo's digital products and strategy. He is currently leading the development of Gojo's Digital Field Application (DFA) in MIFIDA, our partner company in Myanmar.

Published by Marco Giancotti in Blog posts JP
Tags: Innovation, Technology
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