The Expectation of Innovation
25 July 2008
Microcredit undoubtedly represents a creative and original response to poverty. But I think that somewhere along the way, the innovativeness of the idea seems to have translated into an expectation of novelty and ingenuity for all “small-scale entrepreneurs.” I was reminded of this recently while reading a report published by IBM that described microcredit recipients as “creative” and “entrepreneurial.” While I’m certainly no expert on the subject, my time in the field has reinforced my belief that microloans do not generally enable budding entrepreneurs to realize innovative business ideas. Although there’s always an exception to the rule, the loans seem to help ordinary individuals start or expand one-(wo)man enterprises that resemble many other businesses in the marketplace. I don’t believe that this fact diminishes the significance of the loans. Yet I do think that the common media portrayal of microfinance’s potential is out of line with the reality on the ground. I have to wonder if this gap between expectation and reality (as I see it, at least), will eventually hinder the microfinance movement.
Personally, I have to admit that the first time I looked on Kiva, I was a little disappointed. The opportunity to make a loan directly to another individual excited me, of course, but the nature of the projects seemed so provincial. Profile after profile showed conventional businesses with the loan purpose listed as “expanding her business” or “purchasing more goods for sale.” I had wanted to help someone who was doing something new and different. Something more than simply buying goods in bulk at reselling them for a small profit. Perhaps I’m all alone in this respect, but I suspect that many Kiva lenders have the same initial response. Working with CRAN this summer, however, I have had the opportunity to witness borrowers’ modest businesses firsthand, and to learn from them about the nature of work in the informal sector. It has been an eye-opening experience and has helped me to understand the importance of “purchasing more goods for sale.”
In my interviews with clients (most of whom are traders), I always ask how they got into their line of work. I hear two common choruses. Either they inherited the trade from a parent, or they observed the market, noticed a particular set of goods selling quickly, and decided to start selling it themselves. In doing the latter, they instinctively respond to market trends—which always impresses me, but there’s no apparent attempt to define a new niche for themselves or to offer creative solutions to conventional problems. Take the sale of bread, for instance. Generally speaking, there are 4 types of bread in Ghana: sugar bread, tea bread, butter bread, and brown bread (all of which are delicious). And on any given commercial street in Cape Coast, you’ll likely find one or two bread stands, two or three breakfast stands, and seven or more general stores, all selling some combination of these four breads. Why, I’ve wondered, if bread is so popular, does no one experiment with other types of bread? Perhaps a loaf with a crispier crust, a heavier dessert bread, or a good ole fashion banana bread? Why hasn’t CRAN helped a client open a banana bread stand, when all of the ingredients are so abundant?
I suspect that there are many explanations for this—and I’m interested in learning more about them—but I think that the risk involved in any entrepreneurial undertaking represents one major factor. Innovation seems to require that both the buyer and the seller have some breathing room in their expenses. Someone living at or below the poverty line can likely not afford to charter a new path in the bread market. If a poor baker invested all of her capital into an experimental batch of bread that flopped, the result could be disastrous for her and her family. With minimal savings and no official safety net, it could mean that her children go without much food or schooling indefinitely. Furthermore, if the start-up capital came from a microloan, then she’d be saddled with debt too. And from the buyer’s perspective, testing out a new kind of bread may seem risky and unnecessary. Why take a chance with the unfamiliar when a second loaf of bread cannot easily be bought, and when the conventional loaf fills her children’s stomachs just fine? Without the cushion of savings or disposable income, the price of innovation seems to increase significantly. Experimentation seems to become a luxury reserved for the well-off.
So, the risk of innovation may encourage poor individuals to open businesses whose success has already been demonstrated. Beyond the risk factor, however, I think that the nature of the informal sector also encourages the duplication—and the constant desire for a loan to “buy more goods for sale.” The informal economy in Cape Coast comes as close as I’ve ever seen to perfectly competitive market. The barriers to entry, for one, are almost non-existent. Although profits generally increase as one’s supply increases, someone can start a business with only enough inventory to fill a small basket. Such women carry the baskets on their heads and walk door to door searching for customers. With no red tape or minimum requirement of capital, hundred of sellers in the marketplace, and nearly identical products, everyone ends up a price taker. They charge the market price and not a pesewas higher; if they do, they’ll lose their business to the person half a block away selling the same thing. As a result, everyone ends up with slim profit margins. Yet expansion provides a straight-forward way of making more money. With a slim profit margin on each good sold, her profit slowly accumulates as she sells more of the same stuff. The basket carrier seeks to set up an informal stall; the stall owner wants to open a sturdy kiosk; and the kiosk saleswoman aspires to expand into a modest shop.
So that’s what I’ve seem in the field so far. Individuals don’t take out loans to start new, creative businesses. They access credit in order to enlarge their inventory. The traders want to buy more goods for sale; the fishmongers want to buy more fish; the bakers want to purchase more ingredients. It’s not glamorous but it seems to be the pragmatic reality of microfinance. Expecting more from the financial service may be dangerously wishful thinking.
25 July 2008 at 6:40 pm
Well said, Sarah. While microfinance creates opportunity for those who may not have had it before, it often fails to help more skilled workers who are seeking support for advanced business ideas. In other words, while Microfinance helps citizen “A” to continue selling chickens, citizen “B” can’t find funding for his idea to create new mobile phone products. Does this artificially retard emerging markets or does it help traditional businesses grow? Definitely worth researching more.
26 July 2008 at 11:47 am
To build on Jon’s questions:
What are the effects of introducing MORE bread to a perfectly competitive market? Is a perfectly competitive market the same thing as a saturated market? Does the typical “expansion” ever result in the hiring of employees? Is there any economic or social advantages to consolidation in the informal sector (i.e. breadmaker 2 joins breadmaker 1 who is expanding and they divvy up the work to be more efficient or productive)?
27 July 2008 at 5:06 pm
Of course banana bread was your suggested new product! Thanks for the insightful post – I can’t wait to hear about the stories and relationships that informed it. I appreciate your view on the “expanding inventory” projects that frustrated us in P/NPS, and more good questions, as always. Adam and Jon, thanks for your questions, too.
28 July 2008 at 4:03 am
Really outstanding post. I had the same questions/concerns about the innovation (may we say creative destruction, Dr. Crandall?
factor in Cambodia as well and have arrived at some of the same understandings as you said. Very well put!
28 July 2008 at 4:33 am
[...] The Expectation of Innovation [...]
30 July 2008 at 3:08 pm
True Sara, it`s good people try something new. But perhaps most postings on Kiva`s website do state: “expanding her business” or “purchasing more goods for sale,” simply because MFI`s (or perhaps the ones I know in Sierra Leone) do lend to people who already have an existing business, and not people trying to start something new. This minimizes risk both on the part of the MFIs and the clients. As you rightly said, an entrepreneur with a small capital starting something new might lead her into trouble just incase the business does not prove well–it`s better playing with devil you know than the angle you do not know!
1 August 2008 at 9:25 am
Hi,
First time reading this blog and certainly I am really impressed by the quality.
For me this discrepancy is not so surprising – the terms of microcredit seems more to me comparable to a bank loan, and while bank loans are used to start businesses all over the world, more innovative businesses often utilize other types of financing – from friends & family to angels to VCs. In these cases the financing is more targeted towards the higher risk/return market.
Going back to your example – to make it possible for a small scale business to take the even greater risk of expanding into an innovative field (say banana bread), then I would think that the terms of the investment (and here it’s an investment – not a loan!) would need to reflect that. That is I would think that the investor would need to share the risk (or even take most of the risk!) of banana bread failing.
There exists VCs investing into high risk areas (most governments have one connected to their development work) however in the smaller scale (a baker trying to employ 5-10 ppl, expanding into banana bread and so on) I haven’t seen examples as much. For an entrepreneur in Belgium where I am, this would be the stage of friends&family or business angel investment.
So my question would be – is there simply a financing (type of financing) gap here?
Linus
2 August 2008 at 12:25 am
Sarah,
Good to hear things are going well with CRAN. I just had a chance to read your excellent post about innovative entrepreneurs and microfinance. The fact that these loans are really providing safety nets and / or marginal increases in sales and not financing an innovative, creative, unique business was a big aha moment for me as well.
While I was working with Sinapi up in Kumasi, I was working with a German student who is writing her thesis on the very issue you address here. And, she’s writing it in English!!!. So, if you are interested in talking with her let me know. I’m sure she would love to open up a dialogue about this issue.
Dylan
6 September 2008 at 1:12 pm
Hi Sarah,
Thanks for your interesting post. And thanks to my colleague Dylan who let me know about it. Your comment about the bread made me smile because that was my very first impression too.
However, having conducted three months of field research in all ten regions of Ghana, I found that the definition of the creative micro entrepreneur still holds. Creativity is mostly defined by something that is “both new and valuable” (Brodbeck 2002).
Although Sinapi Aba Trust’s micro finance clients do not generally produce unique products such as banana bread, many of them have developed a creative set of survival strategies judging (and juggling of) new opportunities and old obligations.
I interviewed one client who owned a pharmacy where she sold drugs and bread. One client sold nail polish and zips. Another one operated a chop bar, sold clothes and grew pineapples. One woman sold – from the same bowl on her head – fabrics, cosmetics and mangos.
In fact, more than one third of the clients I interviewed for my thesis owned such a type of business. And more than half of all clients used their loan to add products to their businesses that had no synergies with their current products (conglomerate or lateral diversification)! Interestingly, those clients selling the strangest combinations seemed to be the most successful ones. Back to the definition above, such combinations are “new” and at the same time “of value” as they usually result in an over-proportional increase in income.
I have seen businesses where micro entrepreneurs sold car tyres and wedding dresses in the very same shop. Or drums and eggs. Now isn’t that creative and innovative?
I’d love to hear more about your experience. Let me know if you would like to get in touch.
Cheers, Stefanie
2 October 2008 at 8:27 pm
Sarah:
It’s kind of hard and pretentious to not understand why these people aren’t creative in their desire to be “The First Kid On the block”. If you had ever been an entrepreneur you would understand. Some are perceptive
enough to see what works and what doesn’t work and desire to go with what they know will work, because its eat or get eaten.