The COVID-19 pandemic has reminded us all of something that we’ve long known to be true — microfinance institutions (MFIs) need to digitize to meet the challenges of the day and the needs of a modern clientele. However, digitization is not as simple as plugging technology into existing processes and products and declaring “mission accomplished.” It can be a risky undertaking that can cost MFIs a lot of time and resources without delivering the value they imagined for customers or the business.
According to McKinsey, firms fail to meet profitability goals from digital transformation 50% of the time. Our conversations with stakeholders in the microfinance industry have shown us that most MFIs no longer need to be convinced that digitization should be a priority for them. Instead, they are struggling on how to do it right. To help set them up for success, CGAP is working on an MFI digitization agenda that includes documenting the experiences of MFIs that have digitized effectively. A part of this agenda is to help MFIs look out for digitization pitfalls. To do that, CGAP is kicking off a blog series that seeks to identify some of the common missteps that can pose significant challenges to MFIs. In the first post in this new series, we will explore one of the most common of these pitfalls: a poor or unarticulated business case.
MFIs have been digitizing, in one form or another, for more than a decade. When we say “digitizing,” we mean using digital technology to do anything from modernizing select processes, products or channels to completely transforming an MFI’s operations. The reasons for transitioning in whole or in part to a digital business model vary by institution, as do outcomes. Digitization works best when it is designed to meet clearly defined and measurable goals for increasing customer and business value. However, our conversations with MFIs over the years have revealed that few institutions have been able to articulate or demonstrate clear value for customers and the business.
The rationale for digitizing will differ across institutions based on their unique circumstances and challenges. But at the core of any digitization effort should be a clear articulation of how the move will improve the business and how this improvement will be measured. For example, we know that the direct financial benefits of digitization include reduced costs to serve customers (up to 80%) and a significant drop in the cost-to-income ratio (up to 18%). MFIs looking to digitize should start by identifying their reasons for doing so and prioritize the ones that present the most compelling business case. (IFC has a similar list as well):
- Scale. Digital channels can enable MFIs to reach more customers with the same number of staff. This is important for any institution that aspires to serve more customers or cover a larger geographic region.
- Better credit decisions. Digital customer data can enhance MFIs’ market research, customer segmentation and product development. It can also be used to analyze individual customers and make better credit decisions.
- Better products. Better analytics can lead to better, more tailored products. Part of the challenge for MFIs has been to better understand the needs of customers and create financial products that cater to those needs. Improved products bring clear value to customers, and their uptake has obvious business benefits for the MFI.
- Efficiency. The challenge of a high-touch model is that it is difficult for MFIs to be very productive, at least relative to emerging tech-driven operations. This has implications for profitability, scale and speed. To overcome the inefficiency challenge, MFIs can seek out digital approaches that make them leaner (e.g., agency banking or solutions that reduce duplicative loan officer tasks like paper-based remote signup).
- Faster delivery. Digital data can be useful for automating and accelerating underwriting decisions. Faster, automated credit decisioning is important for both MFIs and customers; it minimizes idle capital for MFIs while helping customers get credit sooner.
- Customer engagement. Reaching more customers is not necessarily a good thing if you cannot be responsive to their needs. Digitization creates new ways for MFIs to engage with customers, such as in-app live chat and social media. This makes customers feel valued, which is good for customer retention. Loyal customers mean more opportunities for additional business at reduced cost to the MFI.
After articulating the benefits they hope to get out of digitization, MFIs should identify indicators for measuring whether they are actually benefitting. This means quantifying each benefit as a measure of return on investment or equity, a reduction in costs or some combination of both. MFIs should consider making their digitization goals “SMART” (specific, measurable, achievable, realistic and time-bound). SMART digitization goals have a well-defined scope, increasing the likelihood of successfully delivering on budget and on schedule.
The success of digitization efforts is often undermined by abstract justifications or a focus on indirect benefits. This can happen when digitization is not directed at solving a challenge to the core business, which for MFIs is usually credit. Digitization projects that focus on anything other than the core business make it difficult or impossible to quickly identify their benefits. For example, this can happen when an MFI launches a mobile channel project and the channel itself becomes the focus, as opposed to how it helps grow the loan portfolio or decrease the cost of funds if used for deposit mobilization.
Digitizing right is not easy, but its pitfalls are not inevitable. MFI digitization does not have to yield sub-optimal outcomes for customers or business. It can be transformational when targeted at specific business cases and measured using metrics that directly reflect the core business.
A poor or unarticulated business case is a common pitfall in MFI digitization, but it is not the only one. To learn about other common yet avoidable issues, see the other posts in our ongoing blog series, "Pitfalls in MFI Digitization: What They Are and How to Avoid Them." Also keep an eye out for our upcoming publication, “Digitization in Microfinance: Case Studies of Success,” which will offer an in-depth look at the journeys of several MFIs that have digitized successfully.