Cost Realism in Deploying Technologies for Development Aishwarya Lakshmi Ratan (Microsoft Research India) Mahesh Gogineni (London School of Economics) May 30, 2008 Confronting the Challenge of Technology for Development: Experiences from the BRICS Department of International Development, University of Oxford TEM, Microsoft Research India

Outline Problem area Analytical framework Hypotheses Case studies Implications Takeaways Limitations TEM, Microsoft Research India

Problem area At 24-36% per annum, microcredit is cheaper than moneylender-loans, but not cheap enough. High transaction costs drive up the price (even the best MFIs have operating cost/asset ratios >10%) Can technology deliver cost savings through efficiency gains? If yes, will this drive down the price of credit and expand outreach? Examine client-facing information collection and processing transaction tasks in microfinance workflows TEM, Microsoft Research India

Analytical framework Cost for a given transaction τ is described by a cost function C (V l, V k, O, L, F, N) Where V l = w (wage or labour cost per unit time) * A (inverse productivity indicator or no. of time units per transaction τ) V k = Variable capital cost per transaction τ O = Operating costs per unit labour for transaction task τ L = Total labour hired for transaction task τ F = Fixed costs for transaction task τ N = Number of transactions of task τ Measure efficiency through input cost minimisation Examine the relative cost accrued for task τ under alternate arrangements, LT (low-tech, baseline channel)and HT (high-tech) TEM, Microsoft Research India

Analytical framework Per-transaction gains from using a HT option G = (V l + V k ) LT - (V l + V k ) HT G = w (A LT - A HT ) + V k,LT - V k,HT Total gains across all τ transactions TG = G*N = (w (A LT - A HT ) + V k,LT - V k,HT ) * N OG = (O LT *L LT ) - (O HT *L HT ) OG = L (O LT - O HT ) Profit through cost savings π = TG+OG RoI = π / |F LT – F HT | Σ t=1 6 (π t (1+ρ)) (1+δ) t - |F LT - F HT | NPV = Where ρ is the inflation rate and δ is the opportunity cost of capital TEM, Microsoft Research India

Hypotheses Hypothesis 1 Cost savings from a HT channel maximised when TG is maximised, requiring: -High wage rate (w) -High productivity differential (A LT – A HT ) -High variable cost differential (V k,LT - V k,HT ) -Large number of transactions τ per unit time (N) Hypothesis 2 Cost savings from a HT channel are maximised when OG is maximised. Since O HT will typically be higher than O LT, this requires: - Low operating cost differential (O LT - O HT ) Hypothesis 3 For a given level of net profit through cost savings, the larger the fixed cost differential (|F LT – F HT |), the lower the likely financial sustainability of the HT channel. TEM, Microsoft Research India

Cases Examine 3 microfinance institutions (MFIs) in southern India Chosen for: – the spread they offered as small, medium and large organizations, – their choice of varying microfinance operating models (Joint Liability Groups vs. Self-Help Groups), and – their experimentation with ICTs in client-facing information collection and processing tasks. Follow Kumar (2004) in an activity-based costing approach Two kinds of microfinance data examined: Loan Customer Acquisition and Loan Installment Processing LT channel: PC-based back-end + paper-based front-end HT channel: PC-based back-end + electronic device based front-end In the cases examined, cash transport costs equivalent across LT and HT TEM, Microsoft Research India

Cases Customer Acquisition Urban NBFC Improve efficiency of customer acquisition process Smart phone used by field officer Data sent via SMS or GPRS Cut variable cost by 50% Positive RoI Negative NPV over 6 years Installment Processing Rural SHG Fed Streamline book-keeping and installment data collection Smart phone used by field officer Data sent via SMS Little reduction in variable costs High fixed costs for HT channel Negative NPV over 6 years Installment Processing Rural NBFC Streamline installment data collection Handheld device used by field officer Data uploaded through USB Cut variable cost by 73% Positive NPV over 6 years 1 23 TEM, Microsoft Research India

Cost savings comparison Case 1 + Case 2Case 3 Labour component 1(front-end) w 1 (per month, Rs.)* A 1,LT - A 1,HT (Productivity gain in minutes)19-19 = 02-2 = = 2.65 Productivity gain 1 (share of baseline) Labour component 2 (back-end) w 2 (per month, Rs.)* A 2,LT - A 2,HT (Productivity gain in minutes)14-0 = = = 0.57 Productivity gain 2 (share of baseline) V k,LT - V k,HT (Rs.) = = 0.45 Variable capital cost reduction (share of baseline) G (Rs.) N (number of task τ transactions per yr per branch) ,992^64,800 TG (per yr per branch, Rs.)+26, ,416 O LT – O HT (per L, Rs.) L (per branch)8812 OG (per yr per branch, Rs.)-16,240-13,440-11,640 π (cost savings, Rs.)+10,064-13, ,776 F LT - F HT (per branch, Rs.)-98,462-68, ,000 NPV of π over 6 years^^<0 >0 (PV of π over 6 years) / |F LT - F HT | ^^0.5<03 TEM, Microsoft Research India

Implications The higher the labour productivity gains from the HT channel, the greater the transaction cost savings. The higher the local wage for the task, the higher the productivity-linked transaction cost savings. The higher the variable capital cost reduction, the greater the transaction cost savings. A larger number of transactions per unit of labour/per device greatly multiplies the power of productivity gains per transaction from the use of the HT channel. The larger the operating costs required to run the HT channel (e.g. connectivity costs), the lower the gains from overall cost reduction. The higher the fixed capital investments called for in the HT channel, the more substantial the requirements for high transactional cost savings and low operating cost differentials to ensure the HT channels financial sustainability. TEM, Microsoft Research India

Is tech always cost-efficient? Classic banking, USMicrocredit, India Parallels in PDA-based data collection for healthcare, telecentres for accessing lean data, individual computers for education, etc. $22,000/yr $240/yr $200$ % productivity improvement ~ $ % productivity improvement ~ $30 TEM, Microsoft Research India

Takeaways Can technology deliver cost savings through efficiency gains? Yes, but conditional on the cost context: – the local wage rate for adequately skilled labour – labour productivity, – variable capital costs, – fixed and operating costs per channel, – scale of transactions per device. Among our cases, the successful deployment of a HT channel involved: - operating in an environment of high wages, - achieving high improvements in labour productivity, - reducing variable capital costs significantly, - having low operating costs for the HT channel, - processing a large number of transactions per device. TEM, Microsoft Research India

Limitations and extensions ICTs dont always trump paper! – The view that though capital-intensive, electronic ICTs, with their speed and accuracy, will automatically trump labour-intensive paper-based ways of fulfilling the same functionalities, is mistaken. Extending this work will involve: – Adopting a dynamic, not static lens – Specifying a functional form to calculate allocative and productive efficiency, returns to scale – Endogenising variables: w, N, L – Assessing costs with bundling of transaction tasks per channel (data and payments across products) – Incorporating data quality gains/error correction costs across channels – Testing against a larger sample of data points TEM, Microsoft Research India

Acknowledgements: Ujjivan, CCD/Ekgaon, BASIX, Shabnam Aggarwal, Angelin Baskaran, Kentaro Toyama, Rajesh Veeraraghavan, Rahul De Excel-based costing template available at ? TEM, Microsoft Research India