The expanding market for rural finance
In our 2016 Inflection Point report, ISF Advisors and the Lab issued a call for action to close the agricultural finance gap and spur investment in new models to extend financial services to smallholder farmers. While it is difficult to capture an exact picture of the scale of growth in different service delivery models in the past three years, it is clear that the service industry has evolved.
Just five years ago, commercial banks and microfinance institutions were mostly serving large-scale farmers in commercialized value chains, while non-profits were serving subsistence farmers. Meanwhile, state banks in Asia served all segments, but with the exception of a few impact-driven microfinance institutions (MFIs), there was very little activity in the ‘missing middle’, or those serving emerging rural households with more complex financial needs. Since the Inflection Point report, we have witnessed a fundamental shift in the market. We have started to see a change in how profitability of the smallholder finance market is perceived. Rather than being a beneficiary, the smallholder farmer is increasingly viewed as a potentially valuable customer. And with this change, we have seen a significant influx of private sector, for-profit providers—both innovators and incumbents—who are innovating and expanding the market frontiers.
Key market trends
This market shift has been enabled by a number of trends that have influenced the underlying dynamics of providing financial services to smallholder farmers and agricultural small and medium enterprises (SMEs). Many of these trends interact with and reinforce each other, ultimately combining to create the market shift that has galvanized so many new and established providers into the market.
- Key donors, such as the Mastercard Foundation, the Bill and Melinda Gates Foundation, and USAID, as well as niche impact investors, such as Acumen and Accion, have contributed over USD $250M in targeted funding for smallholder and rural finance initiatives. These impact-driven investments have provided the patient capital innovators require to prove their business models and product-market fit. As such, they have enabled a proliferation of new models, services, tools, and products that change how FSPs engage with smallholder households and rural agricultural SMEs.
- We have seen a rise in the presence of ecosystem “connectors” — such as CSAF, SAFIN or Propagate Coalition — bringing private, public, and philanthropic actors together to coordinate agendas, share learnings, and mobilize action. At the heart of these collective partnerships and donor funding, is the mutual commitment to agricultural transformation and the acknowledgment of smallholder farmers and agri-SME as crucial players in global food and nutrition security.
- There has been an explosion of new digitally-enabled services and approaches to rural finance. These innovations are not only changing what products are being offered, such as new micro-insurance and asset financing options, but are also changing how FSPs conduct their businesses, for example via digitally-based credit scoring, digitally-enabled distribution infrastructure — including e-commerce and interactive farmer training programs. The spread of digitization is impacting both traditional service providers and newcomers, though in slightly different ways, as summarized by CGAP’s latest paper on Fintechs and Financial Inclusion. Traditional players, such as commercial banks and MFIs, tend to leverage digitization to improve their economics and drive operational efficiencies. Meanwhile, the innovators, such as Fintechs and platform players, are leveraging technology to solve pain points that are not addressed by the market incumbents. Underlying this explosion in digital models is a massive expansion in available technologies, alternative data sources, mobile phone ownership, and mobile network infrastructure; providing the basis for digital financial services and digital agriculture solutions that can be layered onto financial services for better risk assessment and service delivery.
- We are also seeing more bundled products and services as more providers recognize that to effectively meet farmer needs and achieve sustainability a more holistic approach is required — where finance is no longer an end in and of itself, but rather, an enabler of greater impact and overall profitability. From a service provision standpoint, this insight implies a fundamental shift, from considering service-level profitability to customer-level profitability, often utilizing cross-subsidization of multiple service lines and product types. From a farmer standpoint, it implies the acknowledgment that to translate access to finance into positive impact, finance must enable access to inputs, markets, and other value-added services that can drive farm productivity and income gains.
- We have witnessed a renewed and increased focus on agri-SMEs and value chain finance, driven by the recognition of the leading role a strong SME ecosystem plays in delivering services to farmers and, more broadly, in creating jobs, driving innovation, and shifting to higher value-added economies. An increasing number of corporations, foundations, and governments are supporting small and growing businesses. At the same time a stronger ecosystem of incubators, accelerators, technical assistance providers, investors and impact funds is emerging to address the distinct finance and business development needs of ag-SME. African Management Initiative, Enablis, Technoserve Entrepreneurship, and Stawi Africa are some examples of organizations that recently designed programs for agri-SME entrepreneurial and/or capital support.
- Finally, we note the emergence of a more sophisticated business-to-business (B2B) market to support the FSPs working in this space. This has taken the form of both B2B products and specialist applications, such as partnership platforms and technology solutions aimed at digitizing specific business processes including, for example, customer registration and data collection, credit risk assessment, or advisory services; as well as business development services (BDS). As business models, product classes, and capital investment structures have become more sophisticated, a specialized set of external consultants (BDS providers) has developed in response, with services ranging from product design, to digitization, to capital restructuring. This strong ecosystem of B2B players has allowed FSPs to focus on their core activitied and outsource risky and time-consuming investments.
A deeper understanding of our market
In addition to trends above, which have reshaped the rural agricultural finance market in the past few years, there has been a significant deepening of the ‘management science’ approach to understanding how actors in this market are functioning. This line of inquiry seeks to gather and synthesize the data of market stakeholders to understand how financial services can be effectively and sustainably provided to smallholder households. In particular, the work of IDH, the Lab, and Mercy Corps have provided significant new information and perspective on the various ‘Service Delivery Models’ used by providers and their potential for both impact and profitability.
Drawing on this intelligence, our State of the Sector report includes a new typology of FSP models. Our segmentation categorizes FSPs according to both their ‘Objective for Service Delivery’ and their ‘Service Delivery Model’.
We have found three distinct types of Primary Goals for Service Delivery, which explain a service provider’s motivation for offering financial and non-financial services to their customers.
- Supply security: Service providers offer services to farmers often in exchange for a purchase agreement. They are motivated by ensuring sufficient supply of produce and, as such, their unit of profitability is not the producer of the commodity but a different actor further downstream in the value chain (e.g. wholesaler). The services themselves, although sometimes monetizable, are a means to an end; the ‘end’ being availability of produce at the right time and in the right quantity and quality.
- Service profitability: Service providers offer services themselves as the core business objective. Recipients (farmers and SMEs) engaging with the services are the unit of profitability, either as each service offered is monetizable and potentially profitable stand-alone (e.g., earning interest on a loan), or as other, often non-ag or non-financial services, offered to the recipient are profitable. In the latter case, some services may not necessarily be profit-motivated stand-alone, but can be cross-subsidized for an overall positive customer value.
- Client outcomes: Service providers offer services to increase the income, wellbeing, independence, and empowerment of the farmer or SME. The services themselves are a means to an end; the ‘end’ being a richer, more resilient farmer or business.
Once we understand why a service provider is offering financial services, we then turn our attention to how they have structured themselves to deliver those services.
There are four types of Service Delivery Models, which describe how the FSP is structured to deliver financial services to clients.
- Focused: Service provider offers a single service (e.g., loans, TA, inputs, analysis) to farmers and SMEs, without partnering.
- Focused Plus: Service provider offers 1-3 services to farmers and SMEs, often partnering with other providers to create the menu of services.
- Holistic: Service provider offers all the services farmers require, without partnering. This is often a very intensive process.
- Platform: Service provider acts as a connector between farmers and affiliated service providers, sometimes offering their own services as well.
Figure 1: Service Delivery Models
By mapping over a thousand existing FSPs according to these criteria, we have established 10 segments that each demonstrate a coherent approach to market engagement and organizational structure. In addition, our research indicated that these segments tended to engage with smallholders and agri-SMEs in different proportions, with some models focused exclusively on one client type and some addressing the needs of both. Of the twelve potential segments, one was unpopulated (Indirectly Profit-Driven, Focused Plus) and the other was so nascent (Directly Profit-Driven, Holistic) that is was designated as a ‘Proto-Segment’. It is important to note that these segments are not necessarily static — service providers can have more then one goal and can be experimenting with more than one service delivery model; thereby lying somewhere along the spectrum of different segments or evolving over time as they scale and become more sustainable.
Figure 2: FSP Segmentation by Service Delivery Model and Primary Goal for Service Delivery
Why we believe this new provider segmentation matters
As innovation has spread through the rural agricultural finance market, there has been a corresponding rise in the diversity and complexity of approaches and models for service provision. We believe that it is vitally important to continue cataloguing and refining our understanding of what exists, what is working, and how these innovations can be used to increase the efficacy and sustainability of FSPs around the globe. Our new typology recognizes some of the most important dimensions of underlying service models, including the scope and configuration of services, their underlying objective, and their client base. By establishing this segmentation, we can begin looking for commonalities and lessons that can be applied with more precision. We believe that this segmentation grants a robust basis for drawing out micro and macro-level lessons that can be used to tackle big questions that we are all asking: What is the impact potential of a given model? What drives profitability in financial service provision for smallholder households and agri-SMEs?
Further, moving beyond basic FSP categorizations (such as ‘ag-tech’, ‘MNO’, or ‘non-profit lender’) to look at underlying models is an important step to also understanding the markets in which they operate. The constellations of providers and models in each market create a services ecosystem that is an aggregate of the individual models — necessitating a segmentation that recognizes how an individual FSP links to the broader ecosystem via partnerships and platform arrangements. No FSP will single-handedly address the service gap in financial services for smallholder farmers, so understanding the dynamics that drive a strong ecosystem will be important for the development of the market.
But perhaps most importantly, this segmentation allows us to better investigate and articulate how to align the three levels of the market — clients, providers, and capital. When asking questions such as “What type of service providers are best suited to serve different farmer segments and pathways?” and “What types and amounts of capital flow should be directed to different types of service providers?” we can move beyond superficial categorizations of FSPs to what ultimately matters — What does the farmer and agri-SME need? How can those needs be met, given the objectives of the FSP? And consequentially, what sources of capital are required given the financial and impact returns we can realistically expect within those circumstances?
What comes next?
Over the next few months we will continue to fine-tune the providers segmentation model to better understand trends and links to farmer pathways and capital market flows. In particular, we hope to:
- Update Inflection Point’s supply-side sizing, adding a new “innovators” sizing that was not considered back in 2016
- Consolidate an updated global database of profiled providers that allows us to stress test the relevance of the new segmentation
- Refine analysis of current and likely future trends
- Articulate how the providers segmentation model links to farmer pathways and to capital market needs, flows, and trends
- Conduct select case studies to help readers visualize how farmer pathways, providers delivery models, and capital flows come together as holistic investment theses