The critical success factors for the extension of financial services to low income customers in South Africa.

LINCOLN MALI

Dissertation submitted to the Henley Management College in partial fulfilment of the degree of Master of Business Administration.

MBA 3696/1999
APRIL 2006

ABSTRACT

The challenge of broadening access to finance originates from the dichotomous nature of the South African economy: South Africa’s first-world financial sector is highly regarded internationally, well managed, adequately capitalised and sophisticated, but is experiencing difficulty in adequately meeting the needs of the developing part of its economy. Consequently, the majority of South Africans (mainly poor and Black) do not have access to financial services. The landscape of that access to financial services includes, transacting banking, savings, credit and insurance. 

Effective access has to take into account at least three dimensions, namely:

• Geographic access: Whether a customer  is near enough to a point of service, which depends more on cost- whether in travel time or expense than distance alone; 
• Affordability: Whether the target customer  can reasonably afford a product; and
• Product features: Whether conditions are attached to eligibility of customers or their use of their product, which effectively rule out a particular group of customers.

Expanding access to financial services to low-income consumers is important not only for the success of South Africa’s broad based empowerment initiatives, but also to reduce poverty and to stimulate more rapid, more widespread economic growth. Better access to savings opportunities can result in greater savings mobilisation; better access to savings and credit can enable faster household formation as well as enterprise creation, and can stimulate higher demand for goods and services in the economy as a whole. For these reasons-both political and the economic imperatives- the issues of access to financial services is likely to be a defining issue in the South Africa’s financial sector for a long time to come. The purpose of this research has been to explore the critical success factors for expanding access to financial services for low Income customers in South Africa. Low income customers in South Africa fall in the category of Living Standard Measure (LSM) 1-5, with a monthly household income range of R0 –R6000.  

The research was qualitative and exploratory in nature. In-depth interviews were conducted with a sample of seventeen representatives from the retail banking institutions, institutions that provide research or consulting support to the banking industry, regulatory and government authorities, practitioners, low income banking experts, banking industry representatives and representatives of consumer and civil society organisations. Respondents were selected through a combination of purposive and snowballing sampling, based on their expertise and experience in the field of low income banking. Content analysis was conducted on the outcomes of the interviews, and results compared to the literature on low income banking.

Based on the data collected, the critical success factors for extending access to financial services for low Income customers in South Africa were identified and discussed. The overall conclusion from both the research and literature is that serving low income customers cannot be done through business as usual; it requires a lot of thinking out of the box. It requires a distinct mindsets and operational innovation in order to achieve business and social goals.

The current banking systems and cost structures in South Africa were based on an offering to a small proportion of society, which was largely White, financially literate, fewer in numbers, had stable jobs and certainty of income. The new customer base which will be the target of extending financial service are likely to be financially illiterate, have uncertain and unpredictable income streams, high unemployment rate, may be unbanked or under-banked and will leave in either remote or hard to access areas. The literature and research’s findings are that mere adaptations of current business models, products, distribution strategies and cost structures will not do. What is required to successfully serve low income customers or the broader society, is a complete rethink of the banking platforms and cost structures, and indeed, also a fundamental reassessment of the entire business model for banking in the country. 

South Africa’s poor, the unbanked and under-banked represents the single largest growth opportunity for South African banks. In order to realise this opportunity and to adapt to a high volume and lower margin business model, South African banks require significant changes across all elements of the marketing mix, and in business models, financial structures, and ultimately in business philosophy. In addition to this, the banks require strategic creativity: innovation in products and brands, pricing and payment, distribution channels, and alliances. 

The literature review and the research have revealed the following as being critical success factors for a profitable, responsible and sustainable low income banking model for South Africa:

A better understanding of the unique characteristics and needs of low income customers that will enable banks to offer superior value propositions.

• Products and services tailored to the needs of low-income customers in terms of both affordability and appropriateness.
• Innovative and cost-effective distribution models for both rural and urban customers.
• Significantly altering the management and operating structure of the banks in order to implement a new culture enabling banks’ engagement with the poor, and leveraging existing social organisations and networks.
• Use of technology to realise operational efficiencies and cost savings.

DECLARATION

I, Lincoln Camagu Mali declare that this research report is my own, unaided work. It is submitted in partial fulfilment for the degree of Master of Business Administration in the Henley Management College in the United Kingdom. It has not been submitted before any degree or examination in this or any other university.

Lincoln Camagu Mali

April, 2006 

DEDICATION 

To Sva, my dear wife 

Your love, support and encouragement made this possible. You give meaning and direction to my life.

To my children, Lihle, Amara and Liam

You are my source of inspiration.

ACKNOWLEDGEMENTS

I wish to express my sincere thanks and appreciation to:

• All the respondents who took time to share their opinions, expertise and experiences with me

• My supervisor, David Murphy, for his critical eye, guidance and encouragement 

• My colleagues and friends for the unenviable task of proofreading, formatting and editing, notably, Thathakahle Khumalo, Bridgete Lamont, Louis van Raveynstein and Xolani Thabethe.

• My mentor, sponsor and advisor, Bob Tucker for his guidance and advice over the last few years

• Sim Tshabalala, my friend, confidant, colleague and comrade for the last 18 years for his guidance and support throughout my career. 

• My parents for instilling in me discipline and dedication from a very young age

• My Team at Standard Bank Convenience banking for their passion and commitment to the cause of low income banking, notably, Charles Mudiwa, Itumeleng Monale, Bridgette Lamont, James Maodza, Portia Mtizira-Nondo, and Sean Robertson.

• My family and friends, my colleagues at Standard Bank Gauteng Province for their support, understanding and sacrifices made over the last few months.  

CHAPTER 1: ORIENTATION 1

1.1 Introduction 2
1.2 Objectives of the Study 2
1.3 Delineation of the scope of the study 2
1.4 Assumptions 2
1.5 Limitations 2
1.6 Importance of the Study 3
1.7 Industry Overview 3
1.8 Clarification of concepts 3
1.9 Plan of the Research Report 4

CHAPTER 2: LITERATURE REVIEW

2.1 Introduction 6
2.2 The size, nature and needs of the low – income market 6
2.2.1 The size of the market 6
2.2.2 The nature of the market 6
2.2.3 Customer needs 7
2.3 Organisational implications of low – income banking 8
2.3.1 Business and low – income markets 8
2.3.2 Banks and low – income markets 9
2.3.3 Profitable business model for low – income customers 10
2.3.4 Future market prospects 11
2.3.5 Organisational structures and resource allocation 11
2.4 The challenge of serving this market 12
2.4.1 Financial issues – Transactional size and efficiency 13
2.4.2 Operational issues – Complexity 14
2.4.3 Relationship issues – Mutual distrust 14
2.5 Products and services 15
2.6 Distribution 16
2.7 Branding and positioning 17
2.8 Technology and innovation 18
2.9 International experience 18
2.10 Legislative and regulatory environment 19
2.11 Conclusion 20

CHAPTER 3: RESEARCH METHODOLOGY

3.1 Introduction 21
3.2 Research method 21
3.3 Research population 21
3.4 Research sample 21
3.5 Data collection method 22
3.6 Questionnaire design 22
3.7 Data analysis 23
3.8 Limitations 24

CHAPTER 4: ANALYSIS OF THE RESEARCH RESULTS

4.1 The research sample 25
4.2 Research Question 1: What is the size of the low-income market? 25
4.3 Research Question 2: What are the needs of this market? 25
4.4 Research Question 3: What are the key characteristics of this market? 26
4.5 Research Question 4: Is this a viable market or banks to pursue? 27
4.6 Research Question 5: Do banks have products and services to adequately serve this market, are these products and services affordable and are they appropriate for the needs of these customers? 28
4.7 Research Question 6: How are these products delivered to low – income customers? 29
4.8 Research Question 7: What organisational capability is required to service low – income customers? 30
4.9 Research Question 8: What role does the regulatory and legislative framework play in low-income banking? 32
4.10 Research Question 9: What are the critical success factors for low income banking in South Africa? 33 

CHAPTER 5: DISCUSSION, CONCLUSION AND RECOMMENDATIONS

5.1 Introduction 35
5.2 The size, nature of this market and its needs 35
5.3 Organisational capability 36
5.4 Products and service required 37
5.5 Distribution 39
5.6 The Regulatory environment 40
5.7 Critical success factors for low-income banking in South Africa 40
5.8 Recommendations 40
5.8.1. Understanding the low-income customers 40
5.8.2 Products and services 40
5.8.2.1 Transactions 41
5.8.2.2 Credit 41
5.8.2.3 Savings 41
5.8.3 Distribution 41
5.8.4 Organisational capacity 42
5.8.5 Regulatory environment 42
5.9 Limitations 43
5.10 Suggested Further Research 43
5.11 Conclusion 44

Bibliography 45

LIST OF APPENDICES

APPENDIX 1: The South African Industry
APPENDIX 2: External factors impacting on South African Industry
APPENDIX 3: Porter’s five forces analysis
APPENDIX 4: FinScope survey on the unbanked in South Africa
APPENDIX 5 Reasons for being unbanked
APPENDIX 6: The cost of being unbanked
APPENDIX 7: Population by LSM
APPENDIX 8: Usage of Financial Services
APPENDIX 9: Access and usage of Financial Services
APPENDIX 10: African Bank’s financials
APPENDIX 11: Capitec’s financials
APPENDIX 12: ABSA and NEDCOR’s Financials for the low income business market
APPENDIX 13: Prahalad’s ‘I’ and ‘S’ growth curve
APPENDIX 14: KPMG study on international bank costs
APPENDIX 15: Physical access to Financial Services
APPENDIX 16: International approaches to the unbanked
APPENDIX 17: Regulatory authorities and other representative bodies
APPENDIX 18: The list of the 17 interviewees
APPENDIX 19: The demographics of the respondents
APPENDIX 20: The questionnaire

CHAPTER 1: ORIENTATION 

1.1 Introduction

 “It is estimated that close to three-quarters of South Africa’s adult population of 24m are unbanked. Driving the banks’ efforts to satisfy this mass of unbanked people is a combination of powerful political, social and economic forces. In blunt terms, the banks can no longer afford to turn their backs on the unbanked. Apart from the possible adverse political ramifications such a stance could easily threaten banks’ profitability”. (Cashmore, 1993) 

“The quotation above is remarkable not for its substance but for its publication date; it was written over ten years ago, before the democratic transition in South Africa in 1994, yet the sentiment could just as easily have been expressed in 2003 during negotiations over the Financial Sector Charter (FSC) between the financial services industry, the government, and community, labour, staff and consumer groups. To some, this shows how little the underlying issues have changed in ten years, while to others, the fact that only half of (rather than three-quarters in 1993) the population is unbanked in 2004 is a sign of great progress” (Porteus, 2004).

Lack of Access to Financial Services or being unbanked in South Africa is a consequence of a set of barriers that currently exclude half the adult population. Reasons for such exclusion include aspects such as affordability, eligibility and appropriateness of products and services (Blarnkius, 2005; Hawkins, 2005). The actual consequences and the costs of exclusion are becoming more severe as the volume of everyday household payments made by bank accounts grows (Stegman, 2001; Barr, 2004 and Hawkins, 2005). According to Stegman (2001), in the modern economy, it is as important to have access to a bank account and financial services as it is to have access to electricity, running water and a telephone.

Stegman (1999) further argues that individuals who have no access to banking services are at an economic disadvantage. This is so because without the ability to save, individuals are denied a range of economic opportunities and, in particular, the opportunity to break out of the “Poverty Trap” (Stegman, 1999). Falkena (2004) concurs with Stegman: he argues that there are both private and social benefits to being banked. These include reduction of theft and the real costs (in money and time) of making payments, the ability to build financial buffers in the form of savings, the taxes, and a reduction in the cultural and financial distance between deprived communities and the rest of the economy (Falkena,2004).  

Kruger (2004) argues that providing basic financial services to the poor has always been a challenge in all countries, but in South Africa, the challenge is urgent because the country must find ways to reduce the entrenched inequalities of incomes, economic opportunities, and access to services left over from years of apartheid. He further argues that tackling this task has to be done in a delicate and balanced manner, as financial sector transformation at too slow a pace may destabilise the sector, while change at too rapid a pace could pose an even greater threat to financial stability (Kruger, 2004). A balance has to be maintained between responding to growing pressures for socio-economic reform and preserving the integrity of and confidence in, the financial sector (Kruger, 2004).  

1.2 Objectives of the study

The objectives of the study are:

• To identify the critical success factors for low income banking in South Africa.
• To recommend future strategies and approaches that would benefit banks, regulators, social partners and, more importantly, low income customers.
• To contribute to an under-researched area of South African business.

1.3 Delineation of the scope of the study 

The study covers low income personal markets in the South African retail banking sector.  These are adult customers whose monthly incomes range from R 0 to R6000; they fall within the LSM 1-5 range and live in both urban and rural areas.  

Banking will be focused on the transaction, payment, savings, credit and risk management offerings to these customers by commercial banks listed on the Johannesburg Stock Exchange (JSE). 

The study will not cover financial services offered by informal financial institutions, third-tier banks and other non-financial banking institutions. 

1.4 Assumption

There is a general acceptance by the banking industry, government and social partners that low income banking in South Africa is not only desirable but a national and business imperative. The extension of financial services to low income customers can achieved in a profitable, responsible and sustainable basis.

1.5 Limitations

The study will not involve primary research on low income customers, but will rely on secondary research such as Finscope (2004), Financial Diaries (2005), Standard Bank Outlook Research (2005), Deutche Bank Bank Report (2005) and Unilever (2006). 

Due to the competitive nature of this market certain key insights and data that give competitive advantage will not be shared, by agreement with the participants in the interviews. 

Some information is highly confidential and will be handled sensitively due to the current negotiations between the government, social partners and the banking industry.   

1.6 Importance of the Study

Low income customers, in aggregate, represent an enormous potential revenue pool and it is in the interest of the banking industry in South Africa to find viable ways of serving this market in a responsible, profitable and sustainable manner. Discovering, developing and successfully implementing viable business models for serving the low income segment may be beneficial to both the banks that discover them and the communities they serve. 

1.7 Industry Overview 

“Anyone walking into one of Johannesburg’s shinning banking malls or sitting across a boardroom table in the offices of one of Cape Town’s insurance giants will quickly understand why the South African financial sector enjoys a reputation for international standards and sophistication. Yet this is only half the story. Should the same person look to townships or rural areas, it would be hard to ignore the fact that millions of South Africans have little or no access to financial services” (Manuel, 2004).  As noted above by South Africa’s Minister of Finance, the banking industry in South Africa is a mature, well established, highly sophisticated and extremely profitable industry. The industry has, however, historically served a fraction of the population, with the entry of Black consumers (who constitute 79% of the population) into the main stream economy there is a lot of scope for growth. The big four banks that dominate the retail banking industry are ABSA, FIRST NATIONAL BANK, NEDCOR and STANDARD BANK (Appendix 1).  Appendix 2 below reflects the findings of the latest KPMG (2004) research on the key external factors facing South Africa’s banking industry. The latest HSBC (2005) study outlines the key industry forces in South Africa’s banking industry. These include pressure on revenue growth, increased competition from local and foreign players, increasing regulatory costs and market resistance on pricing. The study’s conclusions are that future success will depend on how each bank deals with these challenges, “The reality is that the banking industry is likely to move from the current balanced oligopoly to a robust, competitive and multi-layered industry” (HSBC, 2005). Appendix 3 below elaborates on these forces through Porter’s Five Forces Analysis.

1.8 Clarification of Concepts

Access to financial services: Refers to geographic distance, clarity of disclosure to customers, ability to communicate across different standards of financial literacy and liquidity (or ability to access one’s deposits or investments).

BOP: Refers to the Bottom of the Economic Pyramid (or low income markets, or developing countries, or TIER 4, or emerging consumers, the poor. These concepts will be used interchangeably.)

Transaction banking: A secure means of storing, accessing and transferring cash for day-to- day purposes (e.g. current account, or debit card account).

Savings: A secure means of accumulating large lump sums over time (e.g. savings account, endowment policy, mutual fund or ROSCAs)

Credit: Access to liquidity to bridge cash flow shortfalls particularly for major purchases, or for other purposes such as house, car, furniture, clothing or education (e.g. credit card, overdraft, mortgage, hire purchase or micro loan).

Insurance: The provision of cover against a defined risk event or events in return for the payment of a premium (e.g. life insurance, funeral insurance, burial society, household insurance or medical insurance).

Commercial bank: Regulated by the current Banks Act in South Africa, meeting the capital and liquidity requirements imposed by the Act.

Living Standard Measures (LSMs): LSMs are South Africa’s most widely used market segment tool, dividing South African households into 10 groups. It is a move away from segmentation purely on demographics and income. Essentially, the LSM is a wealth measure based on standard of living rather than income. It is mainly associated with living conditions such as consumed durable ownership including cars and major household appliances and degree of urbanisation. It may not be as useful in financial services but is the best available simple segmentation tool. 

Unbanked: Generally refers to those with little or no access to financial services (Finscope: 2003)  

“Loan shark”: Refers to unscrupulous micro lenders.  The terms low income, emerging consumer, unbanked, under-served, under-banked, poor and disadvantaged will be used interchangeably. 

MNC: Refers to Multi National Company 

1.9 Plan of the Dissertation Report

Chapter 1 provides an orientation and background to the study. It also provides for a better understanding of the extent of the challenge of low income banking in South Africa. This is followed by an analysis of the external and industry forces facing the South African banking industry. The Chapter concludes with a definition of the objective, scope, limitation, importance and assumptions used in the study. 

Chapter 2 is a literature review of past and current views on the critical success factors for low income banking. The review includes research done in South Africa, other emerging markets and the developed world. 

Chapter 3 defines the research problem and discusses the research methodology, design and approach.

Chapter 4 analyses the results and conclusions of the research.

Chapter 5 provides a general conclusion and recommendations. 

CHAPTER 2: LITERATURE REVIEW 

2.1 Introduction

This chapter explores the literature on low income banking. It draws on research and authorities from both the developed and developing world. The chapter will first deal with the nature, size and needs of this market. This will be followed by an analysis of the organisational implications of some of the challenges of serving this market and how these may be overcome. The next section deals with organisational capabilities required for success. This is followed by a discussion on products and services, distribution, and technology. This is then followed by an examination of international experience of banking this market from both the developed and under-developed world perspectives. The Chapter is concluded by an analysis that brings out the key trends emerging from the literature review.

2.2 The size, nature and needs of the low-income market

2.2.1 The size of the market

According to the latest Finscope survey (2004) reflected in Appendix 4 below, out of 27 million South Africans over 18 years of age, 13 million (48%) have a relationship with a bank; 10, 4 million (39%) have never banked, and 3, 5 million (13%) have used a bank, but don’t anymore. This means that half of South Africa’s adult population (13 million) are currently unbanked. Appendix 5 illustrates the reasons advanced for being unbanked in both the developed and developing world (Finscope, 2004; Doyle et al, 1998) The key concern evident in the literature is the extent to which financial exclusion reinforces social exclusion, leaving the most vulnerable with little ability to deal with significant shocks (such as unemployment) or overall poverty (Barr, 2001, 2003; Hawkins, 2005). The net effect is that these segments are further excluded from a broad range of other services for which a bank account is a critical prerequisite and are forced to bear the costs and inconvenience of being unbanked (Marshall, 2004; Barr, 2004).(Appendix 6)

2.2.2 The nature of the market

According to the Finscope (2004) research, low income customers regardless of their banking status are in LSM 1 – 5 (Appendix 7). This group constitutes 63% (19 million) of the adult South African population: 79% of them have monthly incomes of less than R1 000; 21% (4 million) have a household income of between R0 – R6 000; 94% of them are Black; 10, 3 million live in rural areas; and 68 % of them are unbanked” (Finscope, 2004). The latest customer research aimed at low income customers reveals that the majority of low income households have women as main buyers and decision makers on day-to-day purchases (Financial Diaries, 2004; Deutsche Bank, 2005). “For the women that control the majority of the household purchases, consumer products are a key mechanism by which they fulfil the over lapping roles of “wife,” “mother”, “economist” and “self”. There is considerable self-esteem derived from managing this spending in the best way possible to care for the family – a task that is rather complex.” (D’Andrea & & Herrero 2005). 

Further research also points out that the main sources of income for low income communities in South Africa, both urban and rural, are remittances, wages and social grants (BMR, 2005). The most significant aspect of these findings is that only 40% of their income comes from wages (as compared to 70% for higher LSM’s); this is so because of the low levels of employment in this market segment (BMR, 2005). Other key characteristics of this market are that the bulk of its transactions are cash-based, and that there are high levels of financial illiteracy and low levels of home ownership (Finscope, 2004; Financial Diaries, 2005; Deutche Bank Report, 2005). Employment in this sector is mainly in the informal sector, contractual or seasonal work, although an increasing number, particularly the urban poor, is being absorbed in the growing tertiary sector of the economy, e.g. tourism, financial services, services industry and construction (Standard bank, 2005). The levels of savings in formal institutions remains low, while informal and community-based savings mechanisms remain strong (Outlook 2005, Financial Diaries, 2005). The levels of indebtedness are generally lower than expected and key decisions on borrowing are made on the basis of the size of the transaction, ability to afford the published instalment rather than the total loan costs, perceived success rate, approachability of the institution and the urgency of the need (AVG, 2002; Outlook, 2005; Financial Diaries, 2005).  

Although these findings are significant, there is a dearth of quality research and soft data on low income customers in South Africa. This is not a unique South African problem.  Goodwin et al (2005), argue that, universally, soft data on the poor is hard to come by and they call for significant investment in segmentation tools based on behaviours and attitudes grounded in caste and culture, rather than economic variables such as household or disposable income.

2.2.3 Customer Needs

Low income customers do not necessarily have simple financial lives; indeed they have to manage their environment to accommodate their financial needs and risks very often without access to a full portfolio of options (Murdoch, 2004). In order to address these needs Hawkins (2005) argues that a financial system that addresses the needs of the unbanked should include reliability, convenience, continuity, and a flexible range of services. According to Caskey et al (2004), low income consumers require the following services from the financial services sector: the ability to make payments, the ability to save and make investments, risk management, credit and loans and the ability to make financial provision for old age. 

Hawkins (2005) points out that in spite of these needs, even those low income customers that have access to financial services, the usage of such financial services is limited and confined to four key products, and namely ATM cards savings/transaction accounts, debit cards and current accounts (Appendix 8).  “This suggests that the distinction between usage and access needs to be maintained and the reasons for each more clearly understood. For instance does the low level of mortgage bond usage reflect inappropriate products or voluntary exclusion“(Hawkins, 2005). Hawkins (2005) asserts that this requires an understanding of the complex choices individuals make with respect to financial services (Appendix 9).

Clancy et al (2002) concur with Hawkins. They argue that in spite of being perceived as ‘poor’, low income customers; in fact, have a considerable amount of money as a group to spend on consumer products. These customer can, according to Clancy et al (2002), “bank and become owners of major assets such as houses when provided with the appropriate structure and incentives”. 

2.3 Organisational implications of low income banking 

2.3.1 Business and low income markets 

There is a strong view that low income customers have been ignored or neglected by business executives because they are perceived as being unprofitable and risky (Prahalad, 2005). There is, however, a new body of literature that is showing more profitable, sustainable and highly successful low income business models (Prahalad, 2004; Segel & Meghji 2005; Ahwireng & Ncube 2005; Austin et al, 2005 and Jacome et al, 2005 D`Andrea and Herrero, 2005). 

CK Prahalad’s pioneering research urges businesses to view the poor not as victims, or a burden on society, but as resilient and creative entrepreneurs and value conscious consumers (Prahalad, 2004). This approach is supported by Austin et al (2005), who call on the private sector to innovate ways of becoming part of the solution, profitably. They argue that the private sector has much to gain from taking a fresh look at low income sectors, putting them on the business opportunity map, trying to identify the barriers that prevent them from accessing traditional markets, and then putting in place innovative schemes that take into account the specifications of that segment (Austin et al, 2005). Their research reveals that the pursuit of business opportunity, response to contextual pressures, and the implementation of philanthropic programmes are primary reasons for companies to forge economic linkages with the poor (Austin et Al, 2005). The approach advocated by Prahalad and Austin et al is endorsed by literature and experiences documented in Latin America, Asia and Africa substantiates (Boza, Ireland, 2003, Marquez and Gomez 2001; De Soto, 1990; Porteus, 2004; Hawkins 2005). 

As evident from the literature above, the current thinking is no longer about whether banks or other multinationals should be involved in providing services to low income customers. It is now about how they should be involved in a profitable, responsible and sustainable manner (Stegman, 2003; Ayala, 2005). This thinking is based on the realisation that “improving the lives of billions of people at the bottom of the economic pyramid is not only a noble endeavour – but it can also be a lucrative one” (Prahalad, 2004). This is so because the ability of a company to help low-income families while improving its own bottom line provides a compelling model for other companies seeking to generate corporate value while improving the lives of some of the neediest families in the world” (Segel & Meghji 2005). The mutually beneficial relationship between business and the poor advocated by Prahalad and Segel and Meghji is supported by Lopes Da Costa (2004). He argues that pressure on margins is forcing South African banks to find extra transaction volume in what many would see as a saturated market. He notes that in South Africa, unlike more mature financial markets who were faced by this challenge, South Africa has an opportunity of a huge market of low income customers still unbanked and under-banked. He points out that the key to service this market is through innovative products, delivery channels, business models – which results in improved lives for the customer and benefits for the banks. He argues that the banks which tackle this challenge will have two major benefits:

• The new customers will become increasingly sophisticated, buy more products and can be migrated to more profitable products and
• The will have contributed to the development of South African society and be eligible for points under the Financial Services Charter, with obvious business spin-offs (Lopes da Costa, 2004). 

In conclusion, according to Sanchez et al (2005), academic attention to business interaction with the poor in strategic management literature has been merely anecdotal. They argue, however, that the recent work of several authors (e.g. Hart, 2005; Hart & Christensen, 2002; Hart & Sharma, 2004, London & Hart, 2004, Prahalad, 2005; Prahalad and Hammond, 2002; Prahalad & Lieberthal, 1998; Prahalad & Hart, 2003; Prahalad & Ramaswamay) has raised the attention of the academic, as well as the business worlds to this subject. In brief, these  suggest that by stimulating commerce and development at the BOP, multinationals could radically improve the lives of billions of people and help create a more stable and inclusive world. 

2.3.2 Banks and low income markets  

 “Banking the poor or the unbanked provides major commercial banks with a huge challenge: if they enter the market, their shareholders become concerned that their investment is at risk, and if this market is pursued recklessly, that can be the result. If, on the other hand, they stay out of this market, it may be left open to the unscrupulous, the “loan sharks” says McFarlane (2003). He argues that perhaps the worst outcome is if this market is under-served and the aspirations of members of society are unmet. This is fully supported by Kim (2001) who is of the view that mainstream banks can and should compete effectively and profitably in low-income markets. She contends, however, that doing so will require a radical rethink of how banks do business with low-income consumers (Kim, 2001). 

“Standard Bank was the first South African commercial bank to enter the unbanked market in 1994. Apart from the large numbers of E Plan clients (3 million); the real significance of its success lay in its demonstrative effect. After concerns about the negative bottom-line impact of poorer customers among banks at the start off the decade, Standard Bank has proved that the low-income transaction market could be profitable. Consequently other banks showed a greater interest in developing their offerings at the low end of the market” (Porteus, 2004).  

According to Lopes da Costa (2004), discovering, developing and successfully implementing viable business models of serving the low income segment can be beneficial to both the banks that discover them and the communities they serve. He sees South Africa’s “unbanked” as a huge opportunity for the South African banks, he argues that this “unbanked market” should perhaps be called the “forgotten” one (Lopes da Costa,2004). He urges banks to modify their approach, their channels and the products they offer to attract these clients: “by coming up with innovative business models, banks will effectively improve the living conditions of those they serve, while also helping themselves” (Lopes da Costa, 2004). 

2.3.3 Profitable business model for low income customers

Goodman et al (2005) argue that the business models targeting the low income consumers call for a change in the mindset of managers from revenue/margin maximization to striving for volume and market penetration. They argue that since the revenue potential of the underserved markets can be as much as five times that of the elite market, sacrificing some short-term unit margin for volume and market share can improve long run profitability (Goodman et al, 2005). “If an organisation’s focus is on short term profits alone, chances are it will not succeed in seeing the poor as a market.  If, on the other hand, they argue, the objective is to catalyze social and economic change at the grassroots, the long term pay-off is likely to be significant” (Goodman et al 2005).

Prahalad and Hammond (2002) support this view, they further argue that managers should focus less on margins but more on capital-efficiency-getting the highest returns on capital employed. According to Prahalad and Hammond (2002), very low capital needs, focused distribution and technology investments, and very large volumes at low margins lead to very high ROCE businesses, creating great economic value for shareholders. Such a model, they argue, can be equally attractive in developed and developing markets (Prahalad and Hammond, 2002). This is endorsed by Prahalad and Hart (2005) who add that, managers should reduce cost levels relative to those in low income markets. They further argue that to create products and services the poor can afford, MNC must reduce their costs significantly to, say, 10% of what they are today (Prahalad and Hart, 2005). 

All of this, however, can not be achieved by fine-tuning the current approaches to product development, production and logistics. They believe that the entire business process must be re-thought with a focus on functionality, not the product itself (Prahalad and Hart, 2005). This is echoed by Goodwin et al, who argues that in order for organisations to succeed, they require significant changes across all elements of the marketing mix, business models, financial structures and, ultimately, in business philosophy (Goodwin et al, 2005). Austin et al (2005), support Goodwin et al (2005) and Prahalad’s (2005) approach: they argue that serving low income sectors requires new business models to cater for their specific characteristics and offer superior value propositions. They add that low income people are cash-scarce and have unpredictable income streams. The critical requirement, therefore, is the ability to invent ways that take into account the variability in the cash flows that make it difficult for them to access traditional markets for goods and services and thus to create innovative purchase schemes (Austin et al, 2005). Porteus concurs, “There are many lessons to be learnt from the successful rollout of pre-paid cell phones services in South Africa for banking product development; not least, that low income people (including for example, students with no reported income) can and do spend money (on average R 100 per month on pre-paid airtime) on services which can satisfy real demands in their lives. (Porteus, 2004)

Organisations that have successfully targeted low income customers such as African Bank, Capitec Bank, and the four major banks’ own mass market offerings give credence to the approaches suggested in the literature. These initiatives and their success are reflected in Appendices 10, 11 and 12 respectively.

2.3.4 Future market prospects

Prahalad (2005) argues that low income markets can collapse the timeframes taken for products, technologies, and concepts to diffuse through the system. He argues that many of the drivers of change and market growth – deregulation, involvement of the private sector in low income markets, digitization, ubiquitous connectivity and the attendant change in the aspiration of people, favourable demographics (younger population), and access to credit –are simultaneously present in low income markets (Prahalad, 2005). He further argues that the resultant “I” curve phenomenon evident below (Appendix 13) is vastly different to the normal “S” curve associated with developed economies. This challenges the management processes of companies which are traditionally suited to “S” curve growth patterns (Prahalad, 2005).  Early signs of a potential “I” curve for South Africa are reflected in South Africa’s current economic boom, huge surge in credit extension, consumer buoyancy, favourable demographics and changes in the confidence, aspirations and economic fortunes of many previously disadvantaged South Africa (Standard bank, 2005). 

2.3.5 Organisational structure and resource allocation

“Business engagement with low income sectors entails generating insights, weighing strategies, and building relationships” (Austin et al, 2005).  It is argued, however, that organisational culture can create some inadvertent biases that need to be changed in the organisation’s context, in order to incorporate the poor; this is so because organisational culture must achieve compatibility with new clients (Austin et al, 2005). They further argue that understanding and overcoming individual and organisational culture gaps are key in developing business with low income sectors. This is so because, “myths and stereotypes of the poor, their needs, aspirations, life styles – are not confined to the psychological mindsets of individuals and groups – they become imbedded in organisational culture “(Austin et al, 2005). 

These sentiments echo the views of Van der Walt & Lagerstrom (2004), who argues that “Given that banks have been actively targeting the Black market (low income) for some time, the value remaining “on the table” is surprisingly large. There are two dominant factors for this: firstly, the level of bank aspiration to service Black/low income customers is often set by local peer comparison and self- imposed limits on feasible achievement, rather than by true stretch targets; secondly, and allied to the first, is the difficulty of changing entrenched mindsets across large organisations”. This is what Prahalad (2005) refers to as “dominant logic”, which is deeply etched in large organisations and restricts their ability to see a vibrant market opportunity among the poor. He further argues that this dominant logic assumes the form of myths and assumptions that dictate the decision and resource allocation processes (Prahalad, 2005)

The strategies of overcoming these challenges include significantly altering the management and operating structure of the company in order to implement a new culture enabling business engagement with the poor, and leveraging existing social organisations, networks, and practices (Austin et al, 2005; Kanter, 2005). These local leaders and social organisations serve as bridging vehicles to facilitate the interface between business and the disadvantaged groups. They bring cultural understanding and credibility as well as specific knowledge and skills missing in the companies (Austin et al, 2005). According to Prahalad (2005), companies that change their dominant logic are in a stronger position to start new ventures in these markets. He goes on to add that companies that have embedded the concept of sustainable development into their corporate culture and values are more able to change this dominant logic (Prahalad, 2005). 

“It is imperative, however, that managers recognise the nature of business leadership required in the Tier 4 (low income) arena. Creativity, imagination, tolerance for ambiguity, stamina, passion, empathy, and courage may be as important as analytic skills, intelligence, and knowledge” (Prahalad and Hart, 2005). They argue that leaders need a deep understanding of the complexities and substructures of sustainable development in the context of Tier 4. They are supported by Prahalad and Hammond (2002), who argue that the biggest change has to come in the attitudes and practices of executives. “Unless CEOs and other business leaders confront their own preconceptions, companies are unlikely to master the challenges of low income markets” (Prahalad and Hammond, 2002).

2.4 The challenges of serving this market 

According to Kanter (2005), serving the poor provides managerial dilemmas for established companies that enter into underserved markets. She argues further that underserved or underdeveloped markets exhibit challenges that reflect characteristics of poor communities and interaction between these communities and the more affluent society that surround them (Kanter, 2005). The particular challenges faced by banks and retailers in serving low income customers are:

2.4.1 Financial Issues – Transaction size and efficiency.

The bulk of bank costs are fixed on a per transaction or per account basis. Thus administering a savings or checking account has certain fixed costs related to opening the account, maintaining records and sending statements. If the account is large and transactions are few, the funds in the account, which often earn no or low interest, can be an important source of relatively inexpensive funding for the institution. On the other hand, if balances are low and, in particular, if low balances are combined with frequent transactions, the account is less profitable. 

Technological innovations such as ATM’s, direct deposit and debit cards, have the potential to significantly reduce costs, thereby making accounts more profitable at lower balance levels. The essential business logic is to make a small profit on each small transaction, and let the volume of transactions aggregate into a substantial bottom –line outcome. 

This view is supported by Kanter (2005), who argues that poor consumers are more likely to engage in large numbers of small transactions, therefore fixed costs per transaction can limit the margin on sales. She further argues that metrics used in mainstream businesses are often inadequate to capture the value inherent in serving this kind of market. She is supported in this view by Ayala (2005) who argues that the relative low purchasing power of the low income segment raises the costs of converting low income customers into actual customers. Prahalad (2005), however, argues that in spite of their limited purchase power as individuals, low income customers in aggregate represent an enormous potential revenue pool and it is in the interest of businesses to find viable ways of serving this market in a responsible, profitable and sustainable manner. 

He argues that if one takes nine countries in the developing world – China, India, Brazil, Mexico, Russia, Indonesia, Turkey, South Africa and Thailand – collectively they are home to about 3 billion people, which is about 70% of the developing world population (Prahalad, 2005). “In PPP terms, this group’s GDP is $ 12, 5 trillion, which represents 90% of the developing world, it is also larger than the GDP of Japan, Germany, France, Italy and the UK combined, this is not a market to be ignored” (Prahalad, 2005). He concludes by asserting that, “by virtue of their numbers, the poor represents a significant latent purchasing power that must be unlocked “(Prahalad, 2005).

2.4.2 Operational issues-Complexity 

According to Kanter (2005), poor consumers and communities sometimes differ from those served by mainstream businesses not only quantitatively (in terms of wealth and income), but qualitatively (with respect to language, knowledge of products and services, access to transportation and residential stability). This phenomenon may, according to Prahalad (2005), be overcome through the creation of a” capacity to consume” based on the principles of affordability (affordability without sacrificing quality or efficacy); access (distribution patterns that take into account where the poor live and their work patterns) and availability. He concludes that the critical requirement is the ability to invent ways that take into account the variability of cash flows of low income consumers that make it difficult for them to access the traditional market for goods and services oriented towards more affluent consumers (Prahalad, 2005). Hawkins (2005) concurs, she argues that overall product usage as well as the indicated preferred design would suggest that the low income customer segment requires products that are amenable to irregular transactions (whether deposits or instalments). More specifically, she argues, products should be able to accommodate irregular payments in respect of timeframes as well as amount (Hawkins, 2005).

2.4.3 Relationship issues – Mutual distrusts

Potential consumers in an underserved market are often culturally different from employees in large companies (e.g. race or ethnicity) and suspicious of large companies for political and other reasons (Kanter, 2005). She is supported by Hawkins (2005), who argues that considerable work is still required to reduce the alienation and distancing barriers that exist. Such barriers, she argues, are cultural, linguistic, educational and technological in nature. This is further confirmed by research conducted by Austin et Al (2005) into Latin America’s poor. It reveals that companies that seek to link with economically deprived consumers, suppliers and partners must be prepared to overcome a variety of cultural, social, geographically and emotional cleavages that split local society (Austin et al, 2005). This is so because “profound differences exist between the educated, middle and upper class groups who are linked to an increasingly global economy, and those left behind in rural as well as urban communities” (Austin et al, 2005). Kanter (2005) believes that the result of this is that established company employees can be sceptical about the market potential and reliability of the underserved and concerned about their personal safety in unfamiliar neighbourhoods, or hold inadequate stereotypes about the population. 

Prahalad (2005) argues that because the mistrust between these communities and the private sector runs deep, private sector firms approaching these markets must focus on building trust between themselves and the consumers. He argues that trust is difficult to build after 50 years of suspicion and prejudice based on little evidence and strong stereotyping (Prahala, 2005). He concludes that through persistent effort and the provision of world-class quality products and services, the private sector can create mutual trust and responsibility between their companies and low-income customers (Prahalad, 2005). This is supported by Kanter (2005) who adds that companies should also invest in community development, community service and consumer education. In addition companies should invest in diversity training for employees, and employ staff who understand the community and its culture (Kanter, 2005).

2.5 Products and services

Prahalad (2005) believes that the starting point of product design is the recognition that the functionality required in products and services in the Bottom of the Pyramid (BOP) market might be different from that available in the developing markets. He argues that, in fact, developers must start from this perspective and look for anomalies from their prior expectations based on their experience with developed markets (Prahalad, 2005). Hawkins (2005) concurs: she believes that product developers should always have the peculiar needs of low income customers as a starting point. This must be followed by an analysis of what they can afford and whether the product should be stand-alone or bundled. A recent KPMG (2004) study has revealed that South African bank costs at the low end of the customer spectrum are regarded as relatively high by international standards (Appendix 14). 

This has been confirmed by the latest report prepared for the Competition Commission (Feasibility, 2006). The report states, “While the banks argue that they price commercially for bank transactions, there are appears to be little relation between the identified costs of payment system activity and the prices charged to the consumer.” (Feasibility, 2006) The report has called for an in-depth evaluation of costs through public inquiry and hearings. This is necessary because the lack of a transparent (and unbundled) price guide for consumers and the lack of an independent adjudicator to which consumer complaints can be directed. (Feasibility, 2006).The report concludes by arguing that in a country where there is considerable political pressure to improve access of under-served consumers to financial services, the absence of these features is likely to be particularly keenly felt (Feasibility, 2006). According to Porteus (2004), the factors that have insulated the profitability of the banking sector (cost cutting and fee introduction or increases) may not endure. “Firstly, the may be no substantial more fat to cut, and there might be less room to increase fees or introduce new ones as this may leave the sector vulnerable to low cost players, or consumers might resist the cost of banking or the banks may not reach lower and moderate income earners. These factors will affect the discourse about access during the next decade (Porteus, 2004).

According to Seidman and Techer (2004), successful product development should be under-pinned by a better understanding of the low income market, a keen appreciation of the changes in this market and a deeper understanding of the opportunities and risks in this market. If this approach is adopted banks would change their approach towards lending to low income customers (Seidman and Techer, 2004).

Reflecting on the pioneering efforts of Standard Bank in low-income banking, Paulson (1999) notes that the most important lesson in providing basic services has been the focus on demand enhancement – by rethinking the needs of the basic banking customer, a new product emerged at Standard Bank that has proved to be valuable to the low-income customer, while providing a way to lower the costs of offering the service. She concludes that the Standard Bank experience has shown that even low income customers can be profitable for banks, which lessons, she argues, should be borne in mind when trying to provide basic financial services for the poor.  

“What is clear is that there is a growing paradigm shift in which function is being emphasised over form – more banks are beginning to focus on the methods needed to deliver the right product functionality to low income customers, breaking free of the constraints of legacy systems and conventional wisdom in order to better meet customer need” (Seidman and Techer, 2004). Prahalad (2005) supports both Paulson and Seidman and Techer. He argues strongly that product development must start from a deep understanding of functionality, not just form. He further argues that marginal changes to products developed for rich customers in the United States, Europe, or Japan will not do (Prahalad, 2005). He further contends that marginal changes to products suited for affluent customers will not do: products designed for, and aimed at, low income customers must take into consideration their unique and difficult circumstances in order to develop functionally that would be relevant and useful (Prahalad, 2005). Hawkins (2005) concurs with this view. She argues that products for low income customers should be able to accommodate both irregular payments in respect of timeframe as well as value. 

2.6 Distribution 

According to Prahalad (2005), distribution systems that reach low income communities are critical for developing this market (Appendix 15). He further argues that innovations in distribution are as critical as product and process innovation (Prahalad, 2005). This is so because “emerging consumers mentally factor in transparent costs to finally arrive at final price for the shopping basket – that is the ‘total purchasing cost’” (D’Andrea and Hererro, 2005). In addition, D’Andrea and Herrero (2005) argue that emerging consumers consider hassle factors, such as the logistical constraints of carrying purchases home, time spent commuting and standing in line. They conclude that the inter-play between physical proximity and pricing are key determinants of store choice (D’Andrea and Hererro 2005).  As consumers do not like to travel very far and consider the transport costs of  round-trip bus fare or a short taxi ride to be significant, companies should always view “access” as a key starting point (D’Andrea & and Hererro 2005).  

Ayala (2005) points out that the distribution of goods and services to economically deprived populations or procuring inputs from them is usually challenging as they often live in remote poorly communicated, or violent areas. He argues further that it is important, therefore, to put in place specifically designed systems or use existing ones operated by other organisations that will take into account the living patterns of their segment (Ayala, 2005). Kanter (2005) contends that companies try to reduce complexity in their mainstream businesses in the interest of efficiency, but she points out that serving poor consumers might not only increase complexity but also require the provision of auxiliary services that make it possible for poor consumers to access the products and services being offered. Prahalad (2005) concurs by arguing that low income markets do not lend themselves to a single distribution solution. He argues that urban concentration represents a problem distinct from that of distribution to dispersed rural communities. 

2.7 Branding and positioning

“The dominant assumption is that the poor are not brand-conscious: on the contrary, the poor are very brand-conscious. They are extremely value-conscious by necessity” Prahalad, 2004). He further argues that brand consciousness among the poor is universal as they, like all other consumers, aspire to a new and different quality of life. The aspirational brands are therefore critical for low income customers (Prahalad, 2004). This is confirmed in recent research into low income customers in different countries in Latin America which revealed that respondents voiced a strong preference for leading and intermediate brands rather than low-priced, economy brands (D’Andrea and Herrero, 2005). The reasons advanced by D’Andrea and Herrero (2005) are that this is not only about aspiration and image, but also quality, performance and support. Lower disposable income means less room for errors in purchases, thus steering the preference towards established, proven brands (D’Andrea and Herrero, 2005).   

According to D’Andrade and Herrero (2005), for low income customers, there is a tension between brand performance and their economic reality; there is usually frustration because they may not have the means to purchase leading and intermediate brands. They argue that in spite of this tension, intermediate and leading brands still represent the largest share of purchases and emerging consumers hesitate to try value/low cost brands (D’Andrade and Herrero, 2005). Although low price points may be attractive, they can also generate mistrust and scepticism about product/service quality.” Lo barato sale caro” (what’s cheap ends up being expensive) is a frequently heard comment in Latin America (D’andrade and Herrero, 2005).

Recent research studies in South Africa (Outlook, 2005; Galileo, 2004; Financial Diaries Project, 2005; SAARF AMPS, 2004; Markinor, Best Brands Research, 2005; AVG Research, 2002) confirm the brand consciousness of low income customers in South Africa. Prahalad (2005) adds, however, that what makes serving this market so challenging is that they are value buyers; they therefore expect great quality at a price they can afford. The challenge to large firms is to make aspirational products affordable to low income customers (Prahalad, 2005). Prahalad further argues that “these consumers represent a new challenge for managers with increased pressure on costs of development, manufacturing, and distribution; as a result these markets will force a new level of efficiency in the MNCs” (Prahalad, 2005) 

2.8 Technology and innovation

“Information and communications technologies can grant access to otherwise isolated communities, provide marketing and distribution channels, bypass intermediaries, drive down transaction costs, and help aggregate demand and buying power” (Prahalad and Hammond, 2002)  They argue that smartcards and other emerging technologies are inexpensive ways to give poor customers a secure identity, a transaction or credit history, and even a virtual address – prerequisites for interacting with the formal economy (Prahalad & Hammond, 2002). Prahalad (2005) argues that the process of innovation for low income markets forces a new set of disciplines and it ensures that innovations are “value –orientated” from the customer’s perspective. This forces attention on both the objective and subjective performances of products or services. 

In relation to banking, Barr (2003) argues that technological advances in banking present a unique opportunity to expand access to the financial mainstream. This is so because payment technology, automatic teller machines (ATMs), and other private sector innovations have all reduced the per-transaction costs of banking. The mainstream financial sector has yet to apply these technologies for the widespread benefit of low income consumers, primarily because individual banking concerns are reluctant to bear the “first mover” costs to significantly expand access (Barr, 2003). 

2.9 International experience 

According to Hawkins (2005), in reviewing the international literature, the most important lesson is that financial exclusion is not a unique South African phenomenon, nor is it a challenge that faces only the developing world; it affects both the developed and developing world Appendix 16). In the United Kingdom, it is estimated that 1, 5 million households (round 7%) do not use financials services at all and a further 4, 4 million (20%) use just one or two.  This latter group may be seen as being on the margins of financial services provision (Hawkins, 2005).  According to Doyle (1998), in the United States some 10 million citizens (around 10%) do not have access to transmission facilities or a current account.  Lack of access to these services is associated with poverty, discrimination and financial exclusion (Hawkins, 2005). 

 The importance of this phenomenon has received increasing attention over the past two decades. According to Hawkins (2005), there are different initiatives aimed at banking low income customers undertaken in both developed and developing countries such as, 

• Social and Banking Charters in Australia, Canada and France; 
• encouragement of branch expansion into isolated areas, or rules about the closure of branches in Canada and India, 
• disclosure rules about branch representation in Australia;
• setting of investment thresholds to channel into disadvantaged individuals, communities and small businesses in Brazil, Nigeria and the USA, and 
• in those countries where there in no legislation or compulsion, the financial institutions have committed themselves to improve the provision of financial access. Examples of these are Australia, Canada, France, the UK and now South Africa. 

According to Prahalad (2005), historically governments, aid agencies, non-governmental organisations (NGOs), large firms and the organised (formal and legal as opposed to extra legal) business sector all seem to have reached an implicit agreement: market-based solutions cannot lead to poverty reduction and economic development. He argues further that the “dominant logic” of each of these stakeholders was different but the conclusions are similar. During the last decade, however, he observes that each group has been searching for ways out of its self-imposed intellectual trap. Now, he argues, there is greater acceptance by all stakeholders of the key role of market-led initiatives in addressing poverty and economic development. 

2.10 Legislative and regulatory environment

“In many developing and transitional countries, regulation and supervision of financial institutions have several weaknesses. These weaknesses represent a serious impediment to the development of financial markets” (Holden & Prokopenko, 2003). In response to these weaknesses, the South Africa regulatory and supervisory authorities have embarked on an ambitious legislative and regulatory reform. Such reform has been designed to broaden the consumer and product base, increase consumer protection, diversify supply, increase competition and create stronger links with international markets. This has seen a number of pieces of legislation that have an impact on the banking industry being passed from 1994.

According to Genesis (2003), the ability and appetite of the market, as opposed to the state, to extend financial services to the poor, are determined by a number of factors. One of the key factors is the regulatory framework for the rendering of banking services (Appendix 17). This is so because banking is a highly regulated industry. Regulation defines the market space, shapes its development and seeks to control the behaviour of market players (Genesis, 2003). “By definition, the nature and content of regulation also impact on the ability of the banking sector to serve the needs of low income customers (Genesis, 2003).

2.11 Conclusion

“In short, the poorest populations raised a prodigious new managerial challenge for the world’s wealthiest companies; selling to the poor and helping them improve their lives by producing and distributing products and services in a culturally sensitive, environmentally sustainable, and economically profitable ways” (Prahalad and Hart, 2005). Katkov (2002) argues that it will not be easy to coax unbanked customers into the arms of the banks, but those financial institutions that make a committed, sustained effort will be rewarded. He further argues that over the next several years, financial institutions will become increasingly active in developing services and products for the unbanked, and will be increasingly successful in winning those customers away from traditional cheque cashers and payday loan providers (Katkov, 2002). 

A Lafferty Report (2002) concludes that the recipe for success for banking the unbanked depends on three factors: the services will have to be market-led, i.e. based on profitable business models, banks will need to market these products adequately, which includes understanding and segmenting the unbanked market, and the services should make use of technology to realise operational efficiencies and cost savings. The literature also reveals a range of other critical success factors for providing financial and other services to low income customers which include a better understanding of the needs of low-income consumers (Seidman & Techer, 2004; D’Andrea & Herrero, 2005), the lowering of the relative costs of mainstream banking services (Kim, 2001; Coetzee, 2004), a change in consumer attitudes about banks (Kim, 2001), services and products tailored to the needs of low-income customers (Kim, 2001; Goodman et el, 2005), relevant and appropriately delivered consumer education (Kim, 2001; Segel & Meghji, 2005), innovative distribution models for both rural and urban conditions (Kim, 2001; Hawkins, 2005; Tucker, 2005; Austin et al, 2005), relevant partnership with retailers, Telco’s and other partners (Kim, 2001) and a long-term view on the future profitability of the market segment (Kim, 2001; Prahalad, 2004; Segel & Meghji, 2005) .

CHAPTER 3: RESEARCH METHODOLOGY  

3.1 Introduction

This chapter describes the methodology employed in conducting the research and discusses the methods used to collect and analyze the data. It concludes with a consideration of the limitations of the research.

3.2 Research method

Unlike quantitative research, qualitative research consists of a body of research techniques that do not measure, but rather seek insight through a less structured and more flexible approach (Gray, 2004). Morse (1991) endorses this view and lists the characteristics of qualitative research problems: the concept is “immature” due to a conspicuous lack of theory and previous research; the available theory may be inaccurate, inappropriate, incorrect or biased; a need to explore and describe the phenomena and to develop a theory; or the nature of the phenomenon may not be suited to quantitative measures. 

The purpose of this particular research was to understand the critical success factors for low income banking in South Africa. This required exploratory research because there is little existing knowledge about this area under investigation. In the light of the qualitative and exploratory nature of the research and given the verbal nature of the data, a phenomenological approach was adopted “to understand people’s perceptions, perspectives, and understandings of a particular situation” (Leedy & Ormrod, 1987). 

3.3 Research population

The research population was defined to focus on individuals who have or have had a leadership, management or oversight role in low income banking for the commercial banks, representatives of social groups, senior members of research institutes, senior members of consumer groups and senior government representatives. These individuals were chosen for their experience, expertise and broader perspective on the key challenges of low income banking in South Africa. 

3.4 Research sample

A sample size of 17 interviewees was used, drawn from a wide range of organisations, perspectives and experiences in order to minimise bias and broaden perspectives on the topic. Appendix 18) A combination of purposive sampling and snow ball sampling was used to further reduce bias during the research. These techniques do not totally eliminate bias as respondents may identify like-minded respondents thus undermining the snowball sampling technique, or the interviewer may select respondents according to personal preference thus undermining purposive sampling. 

The final sample, using both techniques, was a group of highly regarded, well known participants representative of both race and gender demographics (8 Blacks / 7 whites, 13 males /4 females) and made up of practitioners, researchers, academics, government and social groups (Appendix 19). Arguably this contributed to the external validity of the findings because of South Africa’s peculiar race and gender dynamics.  

3.5 Data collection method

Creswell (1994) sees the data collection steps as involving the setting of boundaries for the study, collecting information through observations, interviews, documents and visual materials, and establishing a protocol for recording information. Data was collected through in-depth interviews, a research instrument chosen for its appropriateness to the nature of the study. 

It was recognised that there were limitations to the reliability and validity of this data collection method. Specifically, the content of information and response may vary from one respondent to the next and responses may be biased due to the researcher’s presence (Gordon & Langmaid, 1988; Creswell, 1994).  The variance of the content and information together with the challenge of biased responses was therefore addressed through careful selection of participants best placed to provide the necessary information. The use of both sampling and snowball techniques and the sample size addressed the inherent subjectivity of the in-depth interview as a data collection method. The in-depth interview method chosen was the semi-structured interview, which allowed for both researcher and interviewee to explore subjects in depth within an agreed framework. 

3.6 Questionnaire design

“One typically finds research questions, not objectives or hypotheses, written into qualitative studies (Creswell, 1994). He argues that research questions are the most popular and appropriate form for qualitative studies. He points out that qualitative researchers use the model of a grand tour question followed by a small, limited number of sub-questions (Creswell, 1994).  

The research adopted for the purpose of this study was that of research questions, as opposed to objectives or hypotheses. The research questions’ approach was deemed to be the most appropriate for this type of study. There were five “grand tour” questions followed by related sub-questions; these questions were mainly descriptive in nature and evolved in design during the study as key issues emerged from both the literature review and the research process (Appendix 20).     

The questions were formulated to allow the participant and the researcher to explore and investigate key issues arising during the interview. The use of the in-depth interview based on open-ended questions was preferred because it realizes that “interpretation is an evolving, active process… consisting of the development of rolling hypotheses which are continually being challenged and developed throughout the process” (Gordon & Langmaid, 1988).

The process of interviewing using a few open-ended questions therefore allowed for a dynamic process of interpretation where hypotheses could be tested as the interviews unfolded. Respondents were firstly asked to define the nature, size and needs of the low income banking. Respondents were further asked to address the organizational implications of banking low income customers: the questions asked dealt with structure, products and services, organizational culture, distribution challenges. The respondents were further asked questions about South Africa’s regulatory and legislative framework, as well as the role and efficacy of technology and innovation in banking low income customers in South Africa. Lastly, the respondents were asked to define the critical success factors for low income banking in South Africa. .

3.7 Data analysis

The data analysis process is described as being “eclectic”. There is, therefore, no “right” way (Creswell, 1994). This requires the researcher to be comfortable with developing categories and making comparisons and contrasts. He furthers notes that the researcher should be open to possibilities and see contrary or alternative explanations for the findings (Creswell, 1994). According to Gordon and Langmaid (1988), the researcher “needs to reimmerse himself or herself in the qualitative interviews and organise or structure the content in a form relevant to the objectives of the study. Creswell (1994) argues that data analysis should be done through several simultaneous activities: collecting information through the in-depth semi-structured interviews, sorting the information into categories, formatting the information into a story and writing the qualitative text.  

In this research, the open-ended questions that were used in the in-depth interview were used to test the propositions outlined in the literature review. Interviews with respondents were transcribed before being organised in a structured manner in a database and the responses were then closely analysed “to produce concepts that fit the data” (Strauss, 1987). This was followed by a consideration and grouping of similar concepts into clearly coded categories. To avoid imposing the “a priori definitions of the researcher” in the definition of categories, the identification of categories was not decided in advance, but “emerged out of the examination of the data without firm preconceptions dictating relevance in concepts and hypotheses beforehand.” (Walker, 1985). 

This is an ongoing activity in the research process, as coding is a “continuing form of analysis” and “qualitative fieldwork is iterative: one pass at a site leads to a reshaping of one’s perspective and of one’s instrumentation for the next pass” (Miles, 1984).

Data clustered and compartmentalized into categories was then integrated and analysed per category and then analysed taking into consideration of the interrelationships between categories and the emergence of patterns. The results of the analysis were then assessed in relation to the research questions and propositions developed in the literature review, and a set of conclusions and proposals developed.

3.8 Limitations

In-depth interviews are inherently subjective. This may impact on the reliability of the study and the extent to which the same outcomes will be derived from the same respondents. This potential problem was mitigated by the sample chosen and the structured and logical coding approach to data organisation. Furthermore, to ensure consistency in data analysis and interpretation, the researcher conducted all interviews: fieldworkers were not utilised in the course of the research project.

CHAPTER 4; ANALYSIS OF THE RESEARCH RESULTS  

This chapter describes the results of the research. 

4.1 The research sample

The 17 research respondents represented a total of 12 different organisations. Of these, 9 respondents were from commercial banks (8 respondents were from the four large first tier banks, while one was from a small bank providing financial services to low income customers). The remaining 8 respondents were from non-banking institutions (4 were from institutions that provided support to or conducted research on banking, 2 were from social groups advocating greater access for low income customers, 1 was from the government, 1 from the representative body for the banking industry). 

4.2 Research question 1: what is the size of the low income market?

For research question 1, the respondents were asked about the size of the low income market. The literature revealed that low income customers were in the LSM 1 – 5 category: a market of 19 million customers comprising 63% of the adult South African population. Although there was initial disagreement about the size and definition of the low income market, there was consensus among all the respondents that the Finscope study relied upon in the literature review is the best and most accurate estimate of the size of this market.  The research also confirmed the existence of different segments or groups within the low income base, namely those that are currently banked those that are unbanked and those that were banked but are currently unbanked.   

The respondents further identified the market opportunities that arose from the different sub-segments of the low income base: an increase in product usage for those customers, who are currently banked, access to banking service to those that are unbanked and appropriate products to those that were banked before but are currently unbanked. Although there is a difference in emphasis, the respondents and the literature point out that such market opportunities may only be leveraged if banks focus on ensuring that supply factors are geared towards the market’s needs. 

4.3 Research question 2: what are the needs of this market?

For research question 2, the respondents were asked about the needs of the low income market. The literature indicates that low income customers have to manage a complex set of circumstances and needs without access to a full portfolio of options (Murdoch, 2004). In order to deal with such complexities, low income customers require the ability to transact and make payments, the ability to save and make investments, risk management and cash flow smoothing, the ability to borrow and the ability to make financial provision for old age (Caskey, Duran and Solo, 2004). 

All the respondents pointed out that the lack of understanding of this market makes it difficult for banks to understand its true needs. This lack of understanding of customer needs has a direct bearing on the product usage, product take-up and product knowledge. The research confirms the literature review’s conclusion that low income customers do not necessarily have simple financial lives; it further confirms that they have to manage their environment to accommodate their financial needs and risks without access to a full portfolio of options. The respondents revealed new insight on the needs of the low income customers, in addition to those identified in the literature review: specifically that their financial needs fall into three main categories, namely life cycle events, emergency needs and investment and protection opportunities. 

The literature review and research confirm the following key issues: the true needs of this segment are not fully known and require more research, and that where needs have been identified using the little research available they should be conceptualized in terms of the three categories noted above and addressed through appropriate product design.

4.4 Research question 3: what are the key characteristics of this market?

For research question 3, the respondents were asked to identify the key characteristics of this market. The literature review revealed the following key characteristics of this market: the role of women in the purchase decisions, the trade-offs arising from limited income, the source of income, expenditure patterns, the role of cash, levels of education and financial literacy. The literature further noted the importance of borrowing behaviour, employment status, brand consciousness and aspiration for better life. Finally, the literature pointed out that in spite of their limited resources, low-income customers were extra careful with their money, but would spend more if they get good value (AVG, 2002; Outlook, 2005; Financial Diaries, 2005; Finscope, 2004; Deutsche Bank Report, 2005; Financial Diaries, 2004; D’Andrea & Herrero 2005).

The research confirms the key characteristics identified by the literature review, although respondents pointed out that in the absence of comprehensive research this cannot be conclusive. They also observed that the banking industry currently does not fully appreciate the consumption and buying habits, migration trends, and settlement patterns of this market. 

In addition to the characteristics identified in the literature review, the respondents have identified limited homeownership, significant use of public transport, increasing migration patterns towards urban areas, under-education, limited access to cheaper forms of credit and strong cultural ties as characteristics that are also critical to a better understanding of this market. 

Some of the respondents remarked that the low income segment is neither homogenous nor static and that significant shifts occur within the segment over time. They pointed out that LSM 1 – 2 was in decline, that LSM 3 had become the really attractive entry point for banking and that LSM 4 – 5 represented great growth prospects for both country, retail sector and the and the banking industry. More importantly, they pointed out the driving role played by the Black population in these changes. 

4.5 Research question 4: is this a viable market for banks to pursue?   

For research question 4, the respondents were asked whether this market was viable for banks to pursue. Prahalad (2005) views South Africa as one of the countries to watch, this is so because it’s poor as those in other emerging markets represents a significant latent purchase power that must be unlocked. He argues that this purchasing power may be unlocked through the creation of a ”capacity to consume” based on the principles of affordability (without sacrificing quality or efficacy); access (distribution patterns that take into account where the poor live and their work patterns) and availability (Prahalad, 2005). This is supported by Austin et al, (2005) who argue that serving low income sectors requires new business models to reflect their specific characteristics and offer superior value propositions.

The respondents were asked whether they saw this market as being viable for banks. There was general consensus that, if appropriately pursued, this market represents a huge growth opportunity for the banking industry. All the respondents noted the significant changes in the LSM categories, growing demand among young low income customers, rising product exposure through the mass media, increased migration, better job opportunities and government social development programmes as the key drivers of a sustained consumer boom in South Africa. They pointed out that this consumer boom has resulted in significant changes in low income customer purchase trends of durable white goods.

Although all the respondents agreed on the current, and more importantly, future viability of this market segment, there were differences among the respondents. The most optimistic group of respondents argued that the banking market was currently saturated at the middle and high income level and that the low income group were the only viable source for new growth. The second group of respondents argued that the extent of the viability of this market would depend on proper segmentation, distribution, cost management, and product development challenges. The third and majority group agreed with these two groups but added that external factors such as a growing economy, low inflation, low interest rates, increased employment, decreasing HIV/Aids levels and a stable currency would have a significant impact on the viability of this market segment. These, they said, must be supported by a clear distinction between those low income customers that banks can bank profitably on their own and those that can only be banked in partnership with third-tier banks, retailers, the Post Office and through government subsidies. This last group identified LSM 1-2 as unviable for banks on a strictly commercial basis, while they saw LSM 3 as being under-banked and LSM 4 – 5, and later LSM 6 – 7, as being the most attractive and sustainable. They also noted that the rapid movement of low income customers within the LSMs, the improved economic projections for South Africa and the bias of the population (54% now under the age of 24 years) would enhance the prospects for low income banking.  

4.6 Research question 5: do banks have products and services to adequately serve this market, are they affordable, and are they appropriate for the needs of these customers?

For research question 5, the respondents were asked whether the banks have the products and services to adequately serve this market. According to Prahalad (2005) the starting point of product design should be recognition that the functionality required in products and services in the Bottom of the Pyramid (BOP) market might be different from that available in the developing markets. He argues that, in fact, developers must start from this perspective and look for anomalies from their prior expectations based on their experience with developed markets. Prahalad is supported by Hawkins (2005) who emphasizes the needs and affordability of low income customers and Paulson (19??) who advocates a focus on demand enhancement by rethinking the needs of the basic banking customer. 

On the issue of product appropriateness, the research confirms the findings of the literature review that products which are not designed with the customer’s needs, circumstances and affordability in mind are inappropriate for the targeted segment. The respondents further confirmed that the bulk of products aimed at low income customers were initially designed for middle and high income customers, who are mainly white, urbane, sophisticated and highly literate. They pointed out that the inappropriateness of such products for the low income base is clearly evident in the low incidence of usage, high costs of banking in South Africa, the high levels of unbanked and previously banked customers. 

On the issue of affordability, the respondents were divided. A smaller group indicated that all the evidence suggested that banking services in South Africa were costly by international standards. The larger group accepted that banking services in South Africa may be higher than comparable countries, but maintained that there was a need for a reasonable trade-off between affordability and cost recovery to ensure the sustainability of the business model. 

This group also emphasised the need to recognise the growing paradigm shift in which function is emphasised over form as more banks creatively focus on delivering the right product functionality to low-income customers, breaking free of the constraints of legacy systems and challenging conventional wisdom to better meet customer need. They argued that, though not enough, this advance represents a major departure from the current practice of making marginal changes to products developed for middle and high income customers. 

All the respondents agreed with the findings of the literature review that products aimed at this market should take account of customer dynamics, functionality, affordability and specific customer needs, such as that for irregular transactions.       

4.7 Research question 6: how are these products delivered to low income customers?

For research question 6, the respondents were asked how products were delivered to low income customers. According to Prahalad (2005), distribution systems that reach low income communities are critical for developing this market. He further argues that innovations in distribution are as critical as product and process innovation (Prahalad, 2005). This is so because “emerging consumers mentally factor in transparent costs to finally arrive at final price for the shopping basket – that is the ‘total purchasing cost’” (D’Andrea and Hererro, 2005). In addition, D’Andrea & Herrero (2005) argue that emerging consumers consider hassle factors such as logistical constraints of bringing purchases home, time spent commuting and standing in line. They conclude that the inter-play between physical proximity and pricing are key determinants of store choice (D’Andrea & and Hererro 2005).

The research confirmed all these key findings and there was consensus among the respondents on the need to extend access to financial services for a broader base of low income customers. The respondents pointed out that distribution planning has to appreciate that the costs of branch banking are significantly higher than those of other bank channels. This is so because the cost of transactions greatly reduces with a decrease in the manpower intensity. There was consensus among all the respondents that the current and preferred “bricks and mortar” model based of physical branch banking was ineffective, costly and counter-productive to low income banking efforts. 

They refer to the high costs associated with the current distribution model which include, firstly, direct costs arising from low income customers using an expensive distribution capacity, and secondly, indirect costs arising from the high-cost distribution capacity attending to low value transactions at the expense of clients with a higher contribution. They argued that banks have to significantly reduce costly cash-based transactions in the branch network and migrate them to more cost-effective channels which would be more convenient, accessible and affordable to low income customers. This could be achieved through leveraging new technologies to move transactions away from the branches as advocated in the literature. The benefits of that would be an increase in capacity utilisation of the bank branch, improved branch profitability and a reduction in the costs of banking for low income customers. One of the respondents, however cautions against moving all low income customers to electronic channels, he argues that this may prove counter-productive for two reasons, firstly, more affluent customers have already got access to other channels such as the internet, cell phone and telephone banking are increasingly abandoning traditional branches, and secondly banks have invested in huge distribution networks of physical branches and need to recover this investment by making use of these channels. 

The respondents conclude that future distribution models should be characterised by differentiation, cost effectiveness and innovation. This, according to one of the respondents, would require seamless integrated multiple channels, optimised to maximise customer loyalty and lifetime value. He observed that this would require customer education about the use of cost effective channels.  The respondents agreed that steering customers towards more cost effective channels would have to be tackled sensitively because of South Africa’s history of discrimination. They argued that from a customer perspective being “steered” towards electronic channels that are alien and unfriendly may be construed as a new form of discrimination now based on class as opposed to race. 

The respondents argued that future planning must take into account where the market lives, where it works, settlement patterns, transport routes and channel preferences. They concluded that this should be complemented by appropriate placing, extended hours during the week, extra staff on weekends, deployment of mobile technology, use of a mobile sales force, placement of banking facilities in the workplace in areas with huge volumes and an appropriate mix between bricks and mortar and electronic facilities. 

4.8 Research 7: what organisational capability is required to serve low income customers?

For research question 7, the respondents were asked what organisational capability is required to serve low income customers. In their research on business and low income consumers in Latin America, Austin et al (2005) found three principal reasons for companies to forge economic linkages with the poor: the pursuit of business opportunity, the response to contextual pressures and the implementation of philanthropic programs. They further argue that a critical reading of societal needs can lead the private sector to innovate ways of becoming part of the solution, profitability (Austin et al, 2005). The private sector, they argue, has much to gain from taking a fresh look at low income sectors, putting them on the business opportunity map, trying to identify the barriers that prevent them from accessing traditional markets, and then putting in place innovative schemes that take into account the specifications of that segment (Austin et al, 2005).  

Austin et al’s research also reveals that companies that seek to link with economically deprived consumers, suppliers and partners must be prepared to overcome a variety of cultural, social, geographically and emotional cleavages that split local society (Austin et al, 2005). This is supported by Prahalad (2005), Hawkins (2005) and Kanter  who argue that organisations need to change their ‘dominant logic’ (Prahalad, 2005), business models (Austin et al, 2005), management and operating structure (Kanter, 2005; Austin et al, 2005), financial structures (Goodman et al, 2005), business philosophy (Goodman et al, 2005)and organisational culture (Hawkins, 2005; Prahalad, 2005; Austin et al, 2005 and Kanter, 2005) to be able to engage this market. 

The research confirmed key themes that emerge from the literature review. Firstly, all the respondents agreed that banks currently see this market as being high risk, costly to serve, difficult to reach, unprofitable, largely homogenous and lacking in aspiration. They argued that this is compounded by high levels of financial illiteracy and the additional costs of service to low income customers because of prudential regulation. They further argued that banks have well-educated, sophisticated, middle and high income staff members in key positions who are accustomed to serving and interacting with other high income, professional and business people with whom they share similar linguistic and cultural backgrounds. One of the bank respondents argued that interacting with low income individuals is a very different proposition for bank staff and executives. This, he said, is because bankers have always had a view that upper income segments are the prized catch; there is thus less regard and interest in the lower income segment. This has resulted in negative stereotypes and mindsets that made it hard for sales and service people to work with low-income customers. 

Secondly, all the respondents agreed that future success depends on the extent to which the low income banking business is an integral part of each bank’s strategy. They further argued that all efforts to bank this market must be part of the banks’ core businesses; they should not be merely relegated to the fringes or reduced to the realm of corporate social responsibility initiatives. The bank respondents added that this would positively influence senior management’s perceptions and ensure sustained resource allocation. The one dissenting respondent argued that the current corporate culture in the banks will stifle all innovative and creative efforts to bank this market and that there was thus a need for a separate structure to will ensure autonomy and quicker decision-making. 

Thirdly, the overall view, however, from the vast majority of respondents was that serving low income customers cannot be “business as usual.” It requires creativity and innovation, a change in the approach and attitude towards this market, and a change in the current scepticism of the potential offered by this market because of deeply held myths and assumptions. The respondents further agreed that banks would have to learn to innovate – traditional products, services and management processes will not work. 

Lastly, the respondents confirmed the literature review’s findings that products and delivery systems for this market do not entail a mere adjustment of the current offering to less (or more) affluent clientele, but requires a complete rethink of the banking platforms and cost structures and a fundamental reassessment of the entire business model for banking in the country.

4.9 Research question 8:  what role does the regulatory and legislative framework play in low income banking?

For research question 8, the respondents were asked about whether the regulatory and legislative framework was conducive for low income banking and what changes, if any, were required. Historically, governments, aid agencies, non-governmental organisations (NGOs), large firms and the organized (formal and legal as opposed to extralegal) business sector all seem to have reached an implicit agreement: market-based solutions cannot lead to poverty reduction and economic development (Prahalad, 2005). He observes, though, that during the last decade, each group has been searching for ways out of this self-imposed intellectual trap. There is he believes, a greater acceptance by all stakeholders of the key role of market-led initiatives in addressing poverty and economic development (Prahalad, 2005).

 A number of respondents referred to the Make the Market Work for the Poor (MMW4P) approach as being representative of the new market-led approaches to development. The respondents, with different emphasis, supported the key tenets of this approach, namely, the promotion of interventions that will help the poor help themselves, making existing markets work more inclusively of poor producers and consumers, and ensuring that the benefits of well-functioning markets more widely accessible. In the area of financial service, a recent report confirmed that what was required was to start off where poor people are, then start looking for incentives, institutions, mechanisms that will help them start participating in markets – by strengthening the markets themselves, addressing failures and constraints, and lowering regulatory and other barriers that prevent the poor from entering those markets (CDE, 2006).   

All the respondents agreed that since democratisation, South Africa has seen a great deal of legislative and regulatory reform. The government respondent confirmed that the government had embarked on an ambitious agenda that effectively seeks to shape all aspects of South African society. In financial services, this is evident in the promulgation of a raft of restructuring legislation through which policymakers have sought to broaden the consumer and product base, increase consumer protection, diversify supply, make the sector more competitive, and create stronger links with international markets. The other respondents’ criticism of the current legislative and regularity environment was that there is not enough policy co-ordination, which would enable policy makers to take a wider view of financial regulation and facilitate shifts in policy objectives to enable the required trade-offs and synergies. This, they argued, is compounded by a fluid environment where multiple objectives are arising from multiple sources, inevitably creating multiple and complex impacts on the market. They further argued that such objectives may in some cases, be in competition with each other, or may be mutually re-enforcing.

All the respondents believed that there is a strong case for relaxing or seeking exemptions from the existing regulations for this market segment. The greatest criticism, therefore, was around the cost of regulation, the contradictory nature of the different regulatory and legislative objectives and the onerous requirements for compliance for both customers and market participants.

4.10 Research question 9: what are the critical success factors for low income banking in South Africa?

For research question 9, the respondents were asked what the critical success factors for low income banking in South Africa were. The literature reveals a range of critical success factors for providing financial and other services to low income customers which include a better understanding of the needs of low-income consumers (Seidman& Techer, 2004; D’Andrea & Herrero, 2005), the lowering of the relative costs of mainstream banking services (Kim, 2001; Coetzee, 2004), a change in consumer attitudes about banks (Kim, 2001), services and products tailored to the needs of low-income customers (Kim, 2001; Goodman et el, 2005), relevant and appropriately delivered consumer education (Kim, 2001; Segel & Meghji, 2005), innovative distribution models for both rural and urban conditions (Kim 2001; Hawkins 2005; Tucker 2005; Austin et al, 2005), relevant partnership with retailers, Telco’s and other partners (Kim, 2001) and a long-term view on the future profitability of the market segment (Kim, 2001; Prahalad, 2004; (Segel& Meghji 2005) .

The respondents confirmed a number of the critical success factors identified in the literature. It is very interesting to note the similarities between the research and the literature review: 

• Understanding the low income market

All 17 respondents identified understanding the low income market as a critical success factor for low income banking.

• Appropriate and affordable products and services

All 17 respondents identified having appropriate products and services as a critical success factor for low income banking. 

• Cost –effective distribution channels 

All 17 respondents identified having cost effective distribution channels as a critical success factor for low income banking.  

• Organisational Capability

13 of the 17 respondents identified having the organisational capability as being a critical success factor for low income banking.  

• Use of Technology as an enabler

11 of the 17 respondents identified the use of technology as an enabler as a critical success factor for low income banking.

The following factors were identified by less than 10 respondents:   

• Regulatory and legislative framework – 9 respondents. 
• Positioning and market acceptance – 8 respondents.
• Alliance with retailers, second tier banks and the Post Office – 7 respondents.
• Innovative consumer education and financial literacy programmes – 5 respondents.
• Low cost strategy – 3 respondents.
• Profitable business model – 3 respondents.
• Macro economic stability – 2 respondents.  
• Service – 1 respondent.
• Keeping things simple – 1 respondent.
• Proper segmentation tools – 1 respondent. 
• Cash strategy – 1 respondent.

CHAPTER 5: DISCUSSION, CONCLUSIONS AND RECCOMMENDATIONS

5.1 Introduction

Chapter one presented the broad objectives of the study, its scope, limitations and an outline of the structure of the study. Chapter two presented the literature review. Chapter three dealt with the research problem and the research questions to guide the research, Chapter four dealt with the research design and analysis, data collection and interpretation. Chapter five presented the research findings and compared them to the literature review. The aim of this Chapter is to provide a logical conclusion to the research report. 

5.2 The size, nature of this market and its needs

13 million or 48% of South Africa’s adult population in South Africa are currently banked, 39% or 10, 5 million people in South Africa have never had a bank account and a further 3, 6 % million people, or 13% of the adult population, were previously banked but are now no longer banked. This picture of limited access to financial services is compounded by low product usage among those who are banked. The current product usage is skewed in favour of a small range of products, namely ATM cards, savings/transaction accounts, debit cards and current accounts. It is clear therefore that a better understanding of the distinction between access and usage will enable financial institutions to determine whether this has more to do with product inappropriateness or the existence of formal or informal viable alternatives for the customers. 

The actual size of the low income market, regardless of banking status, is the LSM 1 – 5 range. This group constitutes 63% (19 million) of the adult South African population: 79% of them have monthly incomes of less than R 1000, 21% (4 million) have a household income of between R0 -R6 000, 94% of them are Black, 10,3 million live in rural areas and 68 % of them are unbanked” (Finscope, 2004).

The demand among young low income customers, growing retail exposure through the mass media, increased migration from rural to urban areas, tax breaks aimed at the poor, investment in infrastructure, better job opportunities and government social development programmes are the key drivers of the current sustained consumer boom in South Africa. This has resulted in a marked decline in LSM 1 – 2, and a significant growth in LSM 3 – 5. This manifested itself in significant changes to purchase trends of durable goods such electronic stoves, microwaves, refrigerators, television sets and VCR’s in LSM 3 – 5. If appropriately pursued, this market represents a huge growth opportunity for the banking industry. 

This requires proper segmentation, innovative distribution, appropriate cost structures, demand-led product development challenges, a change in the organisational mindset and an enabling regulatory environment. Within the low income group, LSM 1 – 2 is not viable for banks on a strictly commercial basis, LSM 3 may be profitable if pursued with appropriate technology, appropriate products and relevant partnerships with retailers and other market players, while LSM 4 – 5 represents a huge growth prospect for the banks. LSM 3 – 5 represents the “forgotten” market that Lopes da Costa (2004) refers to. This market has huge growth potential for banks provided they use innovative products, delivery channels, and business models. The result would be improved lives for the customer and benefits for the banks (Lopes dacosta, 2004).  

In order to make this market viable, banks will have to change their business models to the demands of this market, namely market penetration built largely on the ability to manage a low margin, high volume business. This will enable banks to offer low income customers quality products at a price they can afford. In addition to this, narrow margins and the affordability challenge will force banks to be more efficient as cost is the only realistic lever that one can pull to improve profitability. This is confirmed by the latest HSBC (2005) research: “If we are right about the medium – and long-term scenario, the banks will have to reassess their costs structures and service efficiency to help safeguard their currently high profit margins. They appear significantly less efficient than their peers in more developed markets when comparing costs with business volume, but they are helped by low wages”. They conclude that there is room for South African banks to cut costs (politics and unions allowing) in response to any pressure on revenue generation (HSBC, 2005).  

It is important to note that low income customers do not show uniform patterns, but rather have different shopping habits, store selection criteria, and attitudes towards innovation and brand loyalty. This calls for more careful segmentation and a significant investment in time, energy and resources on gaining a keener and deeper appreciation of low income customers’ needs and preferences. 

There is universal agreement that the current Finscope research, though comprehensive, reliable, accurate and useful for banks, is mainly focused on usage. It does not address issues of how consumer decisions are reached, why and how products are used, the frequency of use, the alternatives available, the affordability issue, the trade-offs made and the fundamental needs that lead to product usage. There is thus an urgent need for a comprehensive survey on the needs and behaviours of low income customers. Such a survey should focus on the key features of this market, such as, consumption and buying habits, migration trends, settlement patterns, language preference, technology use, price sensitivity, channel preferences, employment status, and predictability of income, brand preferences and dwelling type. 

5.3 Organisational capability 

South African banks, faced by tight margins in recent years, lack of growth in high end customers, increasing local and international competition, increasing consumerism and regulatory pressure have low income customers as a source of new growth. Rather than considering these consumers just as being poor, with little money to spend, the reality is that they allocate a significant portion of their income to consumer products, therefore representing a market of larger aggregate value than their upper segment counterparts. 

Although it is true that the banks have hitherto not made low income customers their primary target, their future growth in South Africa will be influenced by how they adjust their offering to this vast segment of the population. As Lopes da Costa (2004) asserts, discovering, developing and successfully implementing viable business models of serving the low income segment can be beneficial to both the banks that discover them and the communities they serve. He concludes that this “forgotten market” represents a huge opportunity for South African banks, “by coming up with innovative business models, banks will effectively improve the living conditions of those they serve, while also helping themselves” (Lopes da Costa, 2004). 

The organisational capability required for success includes investing in research that bring client strata specific information such as preferences, views and perceptions of different client groups that can serve as the information with which to design new products and delivery systems. As Coetzee (2003) argues, this will have to involve more than a mere adjustment to to the current products and delivery systems aimed at more affluent clientele. He argues that current banking systems and cost structures in South Africa were based on an offering to a small proportion of society, whereas the offering to the poor or broader society, necessitate a complete rethink of the banking platforms and cost structures, and indeed, also a fundamental reassessment of the entire business model for banking in the country (Coetzee, 2004). 

Finally, Austin et al, (2005), argues that serving low income customers requires new business models, which account for their specific characteristics and offer superior value propositions. He concludes by asserting that doing business with low income customers require strategic creativity: innovation in products and brands, pricing and payment, distribution channels, and alliances. 

5.4 Products and services required  

It is trite to observe that the majority of current bank products aimed at low income customers were conceptualised, designed, and priced for middle and high income customers with regular income and a reasonable level of financially literacy. The banks have adapted such products to the perceived needs of the low income base. These adaptations have included reduction in price, functionality and benefits. 

There is general acceptance that the absence of proper customer research, appropriate needs analysis, and affordability assessments have resulted in sub-optimal product outcomes. Such sub-optimal outcomes include fees that are inappropriate for low income customers (e.g. cash deposit fee, balance inquiry fee and penalty fees for returned debit orders, monthly lump fees which discriminate against those who make few transactions; and high fees if the number of free transactions is exceeded) and expensive delivery systems and platforms and inefficient legacy systems. 

It is clear therefore that one of the key considerations during the product development stage for this segment should be whether the customers can afford the product. In addition to this, banks should ensure that, at the very least, they recover the costs of the product supply, as failure to so will compromise the viability and sustainability of the low income business case. Lastly, to increase product usage, banks should take note of the need to protect and educate these customers about cost-effective banking practices, especially where technology is used to lower the costs of delivery.   

There is broad consensus in both the literature review and the research that the vast majority of current banking products are not appropriate for low income customers as reflected in the low product usage and high ratio of the unbanked. The key weaknesses of current products are that they are not designed to accommodate low value, irregular transactions at low cost (whether deposits or instalments); they are a disincentive to savings; they do not offer appropriate money transfer capability, they do not offer significant benefits to encourage non-cash transactions, and they do not offer the full spectrum of financial services (savings, credit, transactions, payments and insurance offerings). This is so because they have not been conceptualised or designed on the basis of a thorough needs analysis, segment profiling, demographic trend analysis, migration patterns, employment trends, macro economic changes, and government support programmes. 

The notable success of the new Mzansi product (jointly launched by the banking industry and the Post Office in September 2004) which now has 2, 7 million customers (the majority of whom were previously unbanked) demonstrates the pent up demand for affordable banking services among low income customers. Its success has emulated the pioneering effect of the E-Plan offering, whose success Paulson (1999) attributed to a focus on demand enhancement.  She argued that through rethinking the needs of the basic banking customer, the E-Plan product proved to be valuable to the low-income customer, while providing a way to lower the costs of offering the service. The E-Plan and Mzansi products have demonstrated that marginal changes to products suited for affluent customers will not do. They have also demonstrated that products designed for and aimed at low income customers must take into consideration their unique and difficult circumstances in order to develop functionally that would be relevant and useful. Although Mzansi has proved hugely successful, there are still concerns around its pricing compared with peer products (Capitec Bank’s Savings Products), its store of value capability in order to promote savings, its inability to accommodate debit orders, and its inability to provide money transmission.  

5.5 Distribution 

Reducing the barriers to entry experienced by the poor and improving the reach of the banking infrastructure into rural areas, where the majority of the poor are located, are major developmental challenges. According to the Finscope research (2004), only 11% of the 8, 1 million people living on tribal lands have a bank ‘nearby”. This absence of a branch, ATM or other bank channel within close proximity means that the utilisation of financial services is inconvenient and costly for low income customers as they largely tend to live in remote or hard to access places. Although a case can be made for more distribution channels for rural areas to increase the reach of financial services, there is a more compelling, viable and sustainable case for the increase of such channels in urban areas because of a significant urbanisation and migration process from rural to urban areas, higher employment opportunities for the urban poor and higher volumes through the channels and lower costs of building, servicing and maintaining urban channels as compared to rural ones. 

Regardless of the focus, be it rural or urban, there is clearly a requirement to change the design of physical channels to take into account the following factors: improved levels of financial literacy (more assistance is required on the branch floor and better and visible signage), cultural and linguistic challenges (bank staff must be trained on how to serve the poor with respect and dignity, preferably in their own languages), the impact on higher-value customers in outlets where all the segments converge (segmentation by product type, e.g. savings, investments etc) and the need to take into account customer buying patterns (introduce extended hours after work, longer hours over weekends and more staff over lunch times). 

The introduction and development of an integrated distribution system that relies more on cost-effective channels (e.g. mobile account opening) as compared to the current “bricks and mortar” model will help to make branch banking profitable, improve the service and cost to low income customers and enable the different channels to service an ever increasing volume of low customers at minimal cost – thus enhancing the viability of the low income banking business case. Such a model will be better suited to the high volume / low value / low margin characteristics of low income banking.    

Lastly, there are many bank processes and procedures that were designed with high value clients in mind. The introduction of low income customers, in great numbers, requires a full re-evaluation of all processes and procedures to ensure that they are appropriate to the needs of both the market and the bank. Such a review should focus on, improving the customer experience, reducing processing costs, reducing duplication, introducing innovations in the compliance process and improving the capacity to open bulk accounts remote from the branch sites.  

.

5.6 The regulatory environment

There are a number of key objectives to the regulation and legislation of financial services. These are increasing customer protection; improving competition; preventing market failure; removing barriers to entry and enhancing disclosure. There have been a number of legislative and regulatory interventions by the government to address these objectives. These have, however, not had as much impact in improving financial services access as the voluntary financial services charter signed by the government, banks and social groups. Through this initiative, the four large commercial banks together with the Post Office launched a new savings and transaction product aimed at low-income customers. This product, in spite of its limited product functionality has been able to attract 2, 5 million formerly unbanked customers into the mainstream banking sector since its launch in September 2005. This example shows that where the government, the private sector, civil society, aid organisations and the poor themselves all work towards a common goal (increasing access to financial services), there is every chance of success. 

5.7 Critical success factors for low income banking in South Africa 

The literature review and the research confirm that the following factors are critical to the success of low income banking in South Africa: understanding low income customers, appropriate and affordable products and services, cost –effective distribution channels, organisational capability and the use of technology as an enabler.  The other factors, which feature in both the literature review and the research, are an enabling regulatory and legislative framework, positioning and market acceptance, and building alliances with retailers, second tier banks and the Post Office. 

5.8 Recommendations

5.8.1 Understanding the low income customers

• The banking industry, the government and donor-agencies should commission a comprehensive study on the low-income market. It must have a significant sample size that is representative of age, race, culture, gender, language, and geography and employment status.
• Individual banks should devote more resources and effort to a better understanding of the needs and motivations different income groups, their transaction behaviours, channel preferences, product usage and affordability.  

5.8.2 Products and services

5.8.2.1 Transactions

• On the basis of the research on low income customers, banks should develop products that take account of customer knowledge, product design and affordability requirements and their cash flow and cash management needs. This means such products should cater for irregular deposits and transactions of varying value.  

5.8.2.2 Credit 

• The banking industry should develop credit-related products that compete with the micro lending industry, informal financial institutions and unscrupulous micro lenders. This requires significant changes to the current product set in terms of security required, interest charged, disclosure, collection methods, affordability tests and overall pricing.

5.8.2.3 Savings

• Bank product designers should study current informal financial services used by low income customers such as stokvels, umgalelo etc. Although these institutions have obvious limitations, such as lack of security, capital growth and lack of regulation, they remain popular with low income customers because they are low cost, store-of-value solutions that help participants to save for a goal in a supportive environment. 

• Banks should consider separating savings accounts from day-to-day transaction accounts and improve the rates paid on savings accounts. They should also develop ways to promote a more robust culture of savings culture by exploring ideas such as matched savings programmes, saving discipline support, personal financial planning and financial education as key pillars of a savings strategy and product development.  

5.8…3 Distribution 

• Both the highly dispersed rural market and the highly dense urban market of low income customers represent an opportunity to innovate in methods of distribution. Banks should design low cost methods of delivery which are cost-effective for banks and easy to access, affordable user-friendly for the customers. The innovative use of technology is key to this task. 

• Banks should review their current procedures and processes to ensure that they are aligned to a high volume, low margin, high illiteracy and low value customer base. This should include account opening processes, dormancy rules, account management practices, regulatory compliance, documentary requirements, language use and requirements around cash. 

• Collaboration with non-bank institutions should be explored to tackle the costs of physical infrastructure. Retailers, for instance, have in many ways better mastered the art of high volume, low-margin, flexible delivery. Thus partnerships with outside institutions, agencies or formal societies should be vigorously explored. 

5.8.4 Organisational capacity

• The leadership of the banking industry should embrace the challenge of low income banking. This will result in proper resource allocation, sustained effort at innovation and experimentation and a massive change management process aimed at changing negative perceptions and stereotyping of this market. 

• Bank staff need training on important linguistic, cultural and social nuances that differentiate this customer base from the middle and high income customer base they are accustomed to serving. 

• Banks should review their current structures, banking platforms, cost structures, and overall business model to ensure that these are relevant for the challenges posed by low income banking, now and in the future.

5.8…5 Regulatory environment

• Government should ensure that the “Access” targets agreed to by the banking industry are met by 2008 on the basis of sound commercial basis rather than compulsion. This will ensure that there is effective access, greater product usage, improved consumer education and enhanced physical access to bank channels that are user-friendly and affordable to the customer.

• Government should ensure that the cost and burden of regulatory compliance does not frustrate efforts aimed at improving access to financial services. Government should review any regulatory impediments to the “Access” effort. 

5. 9 Limitations

This study has de-limited to the large commercial banks listed on the Johannesburg Stock Exchange which offer savings, transactions, credit and insurance services. This excludes the Insurance Companies, second and third tier banks, retailers, the Post Office, village banks and other institutions that offer formal financial services to the banks. It also excludes informal institutions such as Stokvels, Burial Society, Umgalelo etc, and offer informal financial services to this market. 

In terms of the approach to the study, the focus has been on strategic, organisational and regulatory factors, the study has not examined the detail of financial or economic models to test viability, profitability and sustainability. 

1. Suggestions for Further Research

This research focused on the critical success factors for the extension of financial services to low income customers in South Africa. Further areas of investigation are suggested as follows:

• An analysis of the profitability of the low income segment as compared with other market segments.

• Research on the needs of low income groups, their transaction behaviours, channel preferences, product usage and affordability.

• A critical review on each of the critical success factors identified in this study.

• Investigation on the applicability of the findings o this research to low income banking in the rest of the African Continent and the whole of the Emerging markets.

5.11 Conclusion 

Until recently, South Africa’s unbanked and under-banked low income customers, who make up 63% of the adult population, have been excluded from the South African financial services. They have not been considered a viable market by an industry that has been highly profitable on the back of a client base made of more privileged, sophisticated and affluent customers. This is so because bank executives’ assumptions and perceptions about this market were based on thinking of this market as victims in society, and not as a solution, a business opportunity nor partner in establishing new and innovative business models.

The advent of democracy, competitive pressures from new players, saturation in the middle and higher income groups, pressure from the government and improved economic conditions are forcing banks to re-look at this market. Banks that will harness this opportunity of this “ “forgotten market” are those that challenge their dominant logic and change it, create a better understanding of the economic, social and cultural context of this market and lastly develop key elements of a business model that can fit the high volume/low margin feature of this segment

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