One of the key challenges for postapartheid South Africa is bringing the benefits of the country’s formal, first-world economy to the low-income people who make up a sizable majority of the population. A group of pioneering companies is doing just that—and, in the process, revolutionizing the way they do business.

These trailblazers have adopted an approach that defies the experience and conventional wisdom of the financial-services industry: that the low-income market is at best marginal, at worst disastrous. Indeed, by tailoring their businesses to this market’s needs and resources, they are not only creating tremendous value for their shareholders but also offering bankers and insurers in Asia, Eastern Europe, and Latin America an important lesson.

The problem

Financial institutions dislike the low-income market because they mostly haven’t succeeded in making money in it. Why do they fail?

Products and distribution methods designed for affluent consumers don’t work well with poor people

In South Africa, many traditional, established companies have adapted neither their products nor their distribution networks to the needs of low-income people. Instead, complex products and distribution methods designed for more affluent consumers have been pushed into a market characterized by different forms of behavior, a much less sophisticated understanding of financial products, and far lower revenue flows per customer.

Consider the insurance companies. Their minimum premiums are too high for the poor, and payments are not sufficiently flexible to accommodate pressures on already-stretched incomes. Traditional life policies, for instance, often don’t pay out benefits until three to four weeks after the death of the policyholder, although relatives who have little or no access to other sources of funds or credit may need cash to meet funeral costs almost immediately. Furthermore, neither policy quotations nor issuance and maintenance expenses (such as medical checks and underwriting costs) vary much across different premium levels. Banks have made similar mistakes. They do offer basic accounts, but their products are often complex and costly: low-income customers are chased off by complicated permutations of charges, minimum account balances, and sliding scales for account withdrawals and transactions.

As for distribution, in the low-income market both banks and insurance companies have replicated the infrastructure that serves middle- and high-income people. Fixed costs such as computer systems and allocated expenses from head offices are too high for the mass market, and so is the cost of labor-intensive regional offices and branch networks, although they do cater to the mass market’s preference for face-to-face service. The burden is made all the heavier by too many layers of management.

Despite this failure to understand the low-income market, financial institutions actually can sell ill-suited products to it. The results, however, are quite unsatisfactory. Low-income customers are poorly informed, so they are vulnerable to agents who work on commission—and thus don’t focus on building lasting relationships. Many of these agents are poor themselves, lack training and support, and have no choice but to offer the same range of products across the whole market.

As a result, of course, many agents’ clients can’t keep up payments. Among low-income customers, this usually leads to the surrender or lapse of their policies. Large numbers of policy lapses can drive a business into the ground, since the cost of setting up a policy outweighs its short-lived premium revenue flows. Over time, policy lapses can destroy the brand and the reputation of a sales force among poor people, who rely on word-of-mouth recommendations and endorsements by agents.

A solution

Certain financial-services businesses do make money in South Africa’s low-income market. Some of them compete in the fast-growing, $2.5 billion "microlending" industry, which has exploited the banks’ absence from the low-income credit market. Others are established banks and insurers that have defied the conventional skepticism about poor people. Two in particular stand out: Standard Bank of South Africa and a life insurance company, Old Mutual. Both have succeeded by adopting two principles aimed directly at the problems of the mass market: tailoring products to its needs and serving it with low-cost distribution networks.

Tailored products

In 1994, Standard Bank of South Africa launched the program that became its AutoBank E business. Today, it has 2.6 million low-income customers (out of a total South African working population of 11 million) and is growing at a rate of 50,000 to 60,000 new customers a month. Most of them appear to be people who have never banked rather than defectors from the competition. The economics of the business are strong and improving: the average account balance and account contribution are growing fast (Exhibit 1). Standard Bank is also building future value by strengthening customer relationships and has recently begun extending its low-income product range to capture a larger share of its customers’ wallets.

According to Dennis Jackson, Standard Bank’s mass-market director, research showed that poor people wanted an inexpensive, user-friendly, and safe bank as well as one that would treat them properly as customers and would understand their present and future aspirations. AutoBank E aims to meet these requirements with its card-based E-Plan account, through which customers can make basic transactions and regularly transfer funds into a "savings purse."¹

The bank opens new accounts on the spot if a customer can produce an $8 deposit (of which $3.20 must remain as a minimum balance), proof of identity, and confirmation of a regular income. Cards are issued within minutes; the paper trail is minimal. Pricing is transparent and simple: withdrawals, payments, and fund transfers, irrespective of amount, are all charged a flat 50-cent fee if a transaction is conducted through one of the bank’s automatic-teller machines. There is also a flat-rate monthly management fee of 50 cents. To discourage large single withdrawals, the bank pays higher interest on balances of long duration. And since the high incidence of crime in South Africa’s poor communities makes security a big concern, Standard Bank gives its E-Plan customers "stop" cards they can insert in any ATM to freeze their accounts; they can also stipulate maximum daily withdrawal limits.

One other company stands out for its effort to tap the mass market: Old Mutual, a long-established life insurance firm whose Group Schemes business was founded more than 20 years ago to serve low-income public-sector employees. Using a tailored approach and offering a range of basic death, disability, and savings products, it has built up a customer base of almost one million people in the mass market, some 25 percent of Old Mutual’s total South African customer base.

Although Group Schemes has generated consistently healthy and growing profits for the company (Exhibit 2), Chris Boonzaier, the general manager of Group Schemes, says that until recently "our competitors didn’t want to play in this market; they saw it as an unreliable, low-premium business." In the past few years, however, other institutions have entered the game, and the downsizing of the public sector is now putting limits on the growth potential of that part of the low-income market, which in any case is already fairly well penetrated. Group Schemes is therefore targeting low-income customers employed in the private sector, formal and informal alike, which already provides a sizable and fast-growing share of new premium flows; Boonzaier says it should account for a substantial percentage of the business within three to five years. Group Schemes is also extending its range of products to gain a larger share of the mass-market wallet.

The products themselves are simple, easy to purchase (application forms contain just a handful of questions), and tailored to the low-income market’s needs. Funeral policies, for example, cover not only the policyholders’ immediate families but also parents and other elders—an important requirement in many local cultures. And Group Schemes is competitive on price: thanks partly to group underwriting, its minimum monthly premiums are just 25 percent of those of more upmarket Old Mutual distribution companies.

Educating consumers and building trust are essential for financial firms that deal with poor people

To educate customers and build trust—essential given the inexperience of poorer men and women with financial institutions—salespeople hold simple seminars on family budgeting, financial planning, and calculating interest rates. To strengthen these ties, Group Schemes recruits its sales staff from local communities, supports local schools, and encourages its employees to go on local radio shows to give advice on personal finance.

Of course, low premiums mean that securing regular premium flows is a critical feature—and a huge challenge—in getting mass-market economics to work. Group Schemes uses direct debits and payroll deductions to cut the risk of noncollection, and it leverages partner networks such as the post office to extend its reach. As Group Schemes moves into informal areas, such as traditional African savings clubs, it plans to secure payments by using internal discipline enforced by group leaders and peer pressure.

Low distribution costs

Fundamental to AutoBank E’s success is a distribution network based on automatic-teller machines. Its main component, called an AutoBank E Centre, typically supports 8,000 to 10,000 customer accounts with two to four ATMs and just two or three sales assistants. "One of our biggest concerns," Jackson says, "was that our customers weren’t used to technology," so the staff, fluent in local languages, is trained to teach customers how to use it. AutoBank E Centres are typically located on main streets or in malls—other high-volume locations, such as train stations and minibus taxi stands, are too crime-ridden. Their hours are tailored to the local market, and several outlets do business during extended hours, from 7 AM to 6 PM. So far, 96 AutoBank E Centres have been opened, and a total of 100 more are planned during the next four years.

Costs per outlet are 30 to 40 percent below those of traditional branches, which is vital for the economics of the business. ATM technology greatly reduces the delivery and service expenses of transactions and sales—there is no back office—and the bank minimizes the unit cost of its ATMs by using education and incentives to maintain high transaction volumes.

As for Group Schemes, it has not only kept costs down but also met the need (identified through research) for face-to-face customer contact by targeting low-income affinity groups: pools of people with shared characteristics, such as place of work; membership in trade unions, small-business associations, churches, or sporting groups; or the use of specific transport hubs and supermarkets. Targeting affinity groups has also boosted the productivity of the sales force—critical at low premium levels—by giving agents access to large numbers of people concentrated in a few locations. On average, Group Schemes salespeople sell seven or eight policies a week; traditional agency sales agents, less than two.

Group Schemes salespeople receive support both from the managers of the branches where they are based (who help them gain access to the affinity groups) and from a separate staff of relationship managers who target the affinity groups’ "gatekeepers" (such as trade union executives, human-resource directors, and owners of businesses). Building strong relationships with the gatekeepers has also helped Group Schemes lock out competing offers.

A big factor in the success of this distribution model is the policy of paying the sales force mostly through fixed salaries. Salaried salespeople are more credible to customers than are their commission-based counterparts, and Group Schemes, rather than the salesperson, gets the benefit of selling in bulk. Old Mutual is quick to deal with salespeople who fail to meet their monthly sales targets: they receive additional coaching at first but must leave if they don’t make the grade over three to six months. Even so, agent turnover, at 20 percent a year, is low by industry standards.

For the branch network, Group Schemes chooses nonprime locations, pools space, and economizes on fixtures. As a result, the network’s cost per salesperson is close to half that of traditional South African middle-market life insurers. Group Schemes expects to cut costs further by getting some salespeople to work from their homes or from client sites and by managing them on-line. To gain wider access to the low-income market and to increase profitability further, the business is actively seeking cheaper additional distribution channels.

A model for emerging markets

There are endless opportunities to apply the lessons learned by South Africa’s pioneers to other economies with large low-income populations. In many Asian, Latin American, and Eastern European countries, a majority of the population is poor: in Brazil, for instance, four-fifths of the economically active population earns less than $550 a month; in India, two-thirds of the people have monthly incomes below $125.²

In China, India, and Thailand, as much as 60 percent of the population does not have a bank account or use banking products

The penetration of banking and insurance products in these markets is very low. Life insurance premiums are 0.4 percent of the gross domestic product in Eastern Europe, 0.5 percent in Latin America, and 1.3 percent in the member countries of the Association of South East Asian Nations (ASEAN),³ compared with 3.7 percent in North America and 3.9 percent in Western Europe.⁴ Private health- and accident-insurance premiums are only 1.2 percent of the GDP in the ASEAN countries and 1.3 percent in Latin America and in Eastern Europe, compared with 3.2 percent in Western Europe and 4.7 percent in North America.⁵ Many of the developing world’s people remain unbanked: in China, India, and Thailand, for example, as much as 60 percent of the population does not have a bank account or use banking products.⁶ Nonetheless, in Latin America and Eastern Europe, the move away from government-provided retirement benefits toward a partly or wholly privatized system has opened up opportunities for financial institutions.

In most of these countries, the telltale sign that opportunity beckons is the dominance of traditional distribution methods: in banking, branch-based tellers; in insurance, self-prospecting, commission-based agents. As in South Africa, these models fail to work with low balances and premiums. And as in South Africa, those who tailor their models to the mass market will capture the opportunities.

The poor are neither unbankable nor uninsurable. Financial institutions in emerging markets need not wait for macroeconomic forces to move poor people into the middle-income segment before treating them as serious customers. People with low incomes offer tremendous value now—to those companies bold enough to recast their businesses.