• White papers 2 March 2014

Reverse innovation in financial services: a 10 year outlook

A high growth, high return environment

Progressive financial inclusion together with favourable macro-economic and demographic conditions is resulting in real impact economics, opening the door to effective sustainable growth. Growth Markets represent a $30 trillion opportunity as they evolve from export-led centres of manufacturing and production to consumer-centric societies by 2025, and they provide fertile ground for some degree of free experimentation, given the low cost of change presented by their open environment. This creates an opportunity for Financial Services businesses in Growth Markets to revolutionise the sector, disrupting domestic as well as global markets. This is what we understand by the reversal flow of innovation: entrepreneurial creativity and technological innovation born in Growth Markets expanding and influencing developed ones.

Favourable macro-economic and demographic conditions in Growth Markets

An estimated explosive GDP growth for the upcoming decades, a young population pyramid (translating into 1bn people entering the consumer class by 2025), and increasing internet usage and mobile penetration create the best environment for accelerated Financial Services innovation carrying strong financial inclusion and impact benefits. It is estimated that every 10% increase in mobile penetration leads to 1% increase in GDP. Additionally, a 1% increase in financial inclusion was calculated to increase GDP per capita growth by 3.6%.

The opportunity for technology-led Financial Services

Stricter regulation in developed markets was reinstated following recognition that the amalgamation of capital and services provision was one of the root causes of the 2008 financial crisis. This comes with high compliance costs for banks: $34 billion is what US banks are expected to pay yearly to satisfy Dodd-Frank rules. Capital-light and technology-led Financial Services are one of the few growth areas in an ever more constrained industry, and they are revolutionising a market perceived to be mature.

Cambrian explosion of Financial Services technology startups

As distribution models move away from physical to digital channels, entry points for technology startups that are competing on price, convenience and customer experience are emerging, thus enabling industry-wide disruption and displacement of incumbents. Thanks to a high growth and margin environment, and not threatened by legacy infrastructures and constraining regulatory capital requirements (as present in developed markets), Growth Markets innovators are succeeding.

Despite financial services importance in facilitating wealth creation, there is an under-penetration of financial services in Growth Markets, while those that do have an account are under-utilising it. However, consumer behaviour, following demographic trends and a wide-spread perception that traditional Financial Services are too expensive, is greatly changing, enabling the adoption of digital business models.

Financial inclusion driving economic growth

We believe that for Financial Services in Growth Markets private equity can play an instrumental role in achieving Prahalad’s vision of “Serving the World’s Poor, profitably”. Through reverse innovation, serving both growth and developed markets, profit acts as an engine for global welfare.

It is now the right time for private equity to focus on Growth Markets’ Financial Services. We are supremely excited by the promise and challenge of investing in these markets. We are also humble enough to realise that the task ahead is immense and open minded enough to warmly welcome any partners who share our mission to drive positive change in Growth Markets.

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