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SESSION 2 The Price and Cost Curves
Paris July 2012
Promo%ng Transparent Pricing in the Microfinance Industry
Agenda 1. Review recent challenges in microfinance 2. Introduc=on to the confusing world of micro-‐credit
pricing 3. Averages are decep=ve in microfinance! 4. To understand microfinance, you need to
understand “the curve” 5. Transparent pricing is necessary to make the
flawed market of micro-‐credit func=on beMer
Two common ques=ons without simple answers:
1) What is the “market price” of
microcredit?
2) What is a “responsible price” for microcredit?
Average Price
Responsible Pricing Range
Too Low!
Too High!
Is there a curve in other countries?
The interes=ng ques=on: Are ins=tu=ons “off-‐of-‐the-‐curve” pricing responsibly?
Why is there a price curve for micro-‐loans?
Are there cost curves in real data?
Cost Components that Affect Pricing
Component
Financial Costs 10% Loan Loss 2% Opera=ng Costs 20% Profit 3%
Total Price 35%
In the Philippines, we find a curve not only for prices, but also for Opera=ng Costs.
Common industry benchmark of 15-‐20% OpCost Ra=o is appropriate for larger loans
But smaller loans generate an Op Cost Ra=o well in excess of 20%
No=ce that in all three countries there is a remarkably consistent spread between OCR
and Yield
Understanding the cost curve for micro-‐loans
Efficiency: Opera=ng Cost Ra=o The formula for the ra=o:
Annual Opera=onal Cost -‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐-‐ Average Loan Por[oliio
We will analyze at the level of a single loan • Cost to process and disburse a loan (once per loan) • Monitoring cost (monthly cost) • We annualize these cost
Pricing for Different Products
Component $100 Loan $1000 Loan
Financial Costs 10% 10% Loan Loss 2% 2% Opera=ng Costs 50% 15% Profit 3% 3%
Total Price 65% 30%
Responsible Behavior is an Obliga=on
• Microfinance take place in quite imperfect markets • Our clients are the very poor • We hold power, with power comes responsibility • Micro-‐credit is not an exchange nego=ated between equal par=es
3. The tempta=on of large profits can lead some to irresponsible prac=ce
4. Irresponsible prac=ce leads to client abuse 5. This repeats the paMern of the past 2,000 years.
Microfinance was created to be an alterna=ve path.
The Income Distribu=on Pyramid
Individual Lending
Solidarity Groups
Village Banking
Self-‐Help Groups
Microfinance is a rare industry with nearly 100% of clients at boMom of the pyramid.
How much weath should be transferred from the poor to the rich?
How shall we discuss fairness and ethics?
MFI’s Costs
Defining a Responsible Price
+ MFI’s Choice of Profit
MFI’s Costs
Defining a Responsible Price
= Price Set by the MFI
+ MFI’s Choice of Profit
MFI’s Costs
Defining a Responsible Price
What Price Can the Poor Afford?
= Price Set by the MFI
+ MFI’s Choice of Profit
MFI’s Costs
Defining a Responsible Price
What Price Can the Poor Afford?
= Price Set by the MFI
+ MFI’s Choice of Profit
MFI’s Costs
Defining a Responsible Price
Step 3: Factors influencing client ability to pay
Step 2: Analysis or current product-‐level prices
Step 1: Cost Curve and Choice of Profit Level
Pricing for Sustainability must address the reality of the COST curve
Mexico, Brazil, and Colombia not present at
100%
Only Mexico, Brazil, Colombia and Philippines
at 5%
GNI/Cap Mexico Brazil Colombia Philippines Azerbaijan5% 50% 60% 55% 60%10% 33% 35% 28% 32% 21%25% 20% 24% 18% 22% 17%50% 19% 12% 16% 14%100% 12% 12%150% 10%200%
Operating Cost Ratio, average per county data
GNI/Cap Ecuador Nepal Bosnia Bolivia Bulgaria Average5% 58%10% 25% 28%25% 15% 13% 15% 25% 16% 18%50% 10% 8% 11% 17% 12% 13%100% 7% 5% 7% 14% 8% 9%150% 13% 7% 10%200% 12% 6% 9%
Operating Cost Ratio, average per county data
Price curve follows cost curve
Price curve follows cost curve
A new way to look at the data
1. Is an MFI close to the curve in its country for costs? For por[olio yield?
2. If not, why not? 3. What spread has the MFI selected between its
costs and the price it has chosen?
Pricing for Sustainability
Pricing for Profits
• Must the ins=tu=on be sustainable?
The Ins=tu=on
A Deeper Discussion of “Sustainability”
• Must the ins=tu=on be sustainable?
The Ins=tu=on
• Must each product be sustainable? • Fair for the rich to subsidize the poor? • Fair for the poor to subsidize the rich?
Each loan product
A Deeper Discussion of “Sustainability”
• Must the ins=tu=on be sustainable?
The Ins=tu=on
• Must each product be sustainable? • Fair for the rich to subsidize the poor? • Fair for the poor to subsidize the rich?
Each loan product
• Must each individual loan be sustainable? • Fair for some clients to subsidize others?
Each client within a loan product
A Deeper Discussion of “Sustainability”
The Profit/(Loss) Component is the Choice of Management
Pricing for Profits
Pricing for Profits
Pricing for Profits
Proposal
Let’s embrace a respec[ul and serious dialogue on these issues of
prices and profits
What do YOU think?
If your MFI is new, and your costs are therefore high, is it fair to set a high price and hide it from your clients?
What do YOU think?
If the market is compe==ve for $2000 loans, is it fair to make high profits from $200 loans to subsidize the $2000 loans?
What do YOU think?
What is the maximum ROA that is fair for $5000 loans? A) 2% B) 5% C) 10% D) 20% E) no limit
What do YOU think?
What is the maximum ROA that is fair for $200 loans? A) 2% B) 5% C) 10% D) 20% E) no limit
Promo=ng Transparent Pricing in the Microfinance Industry
