NB Financial Innovation

November 13

Nate Gonzalez

Directed Remittances: Are “free” in-kind transfers exciting enough to lure customers?

It’s no secret that remittances from migrant communities have extremely important social and economic impacts on emerging markets. According to recent estimates form the World Bank, more than $500 billion in remittances will be sent to emerging market countries in 2013. These money transfers represent meaningful proportions of economic activity for recipient nations, accounting for over a third of GDP in some countries. Given the amount of money we’re talking about and the outsized economic importance remittances have for recipients and their countries, it’s surprising that the market has only experienced incremental levels of innovation over the years.

The traditional business model for sending and receiving remittances, dominated by Western Union and MoneyGram, was partly disrupted by the advent of online-based models (e.g., Xoom) that digitized the sending experience in the early 2000s. New online players allowed customers to send money home over the Internet instead of walking down to the local money transfer agent at the corner store. The result was lower prices. Online remittance companies benefited from the fact that they didn’t incur the cost burden of building out a proprietary agent network in sending countries and were able to partner with existing agent distribution cash out points in recipient nations. This allowed players like Xoom to charge customers an average rate of 5-7 percent to send money to a friend or family member, whereas Western Union and MoneyGram were still charging an average of 10 percent. While disruptive, the rise of the online-sending model is not wildly innovative. The traditional model merely shifted from analog to digital; the sender is still paying to transfer their money abroad and the recipient is still walking to a local agent/partner location to pick up their cash.

Today, however, that paradigm may be shifting.

At Accion Venture Lab, we’ve seen a number of more nuanced business models sprout up throughout the emerging-market regions we cover. A handful of startups are pioneering “directed remittance” models: Instead of sending cash to family and friends, these new entrants are transferring value in a variety of form factors, including gift vouchers redeemable at local merchants (e.g., grocery stores, pharmacies, department stores), bill payments made to local utilities, and top-ups for prepaid mobile phones. The directed remittance-to-merchant model is being launched by startups like Ayannah, Regalii, Quippi and POMS. Other players, like iSend and Bluekite, have chosen to start by directing remittances toward mobile top-ups and guaranteed utility payments, and are already expanding the use cases their platforms support.

The form factor shift is interesting, but what is potentially more disruptive is that many of these options come at a dramatically lower cost for senders and receivers – or even free. Instead of sending $100 through Western Union to a friend in Mexico, who receives $90 in cash after fees, I could now send him a gift voucher for $100, which can be redeemed in full at the grocery store down the street from his house.

Accordingly to the World Bank, approximately 60 percent of all remittance dollars are spent on consumption goods (e.g., food, basic household items). Furthermore, the World Bank estimates that dropping the price of remittances by 5 percent creates $16 billion in savings a year for senders. So why not dramatically reduce the frictional cost that senders typically pay to support consumption based-expenditures? In theory, the directed remittance model frees up additional funds that would have been spent on transfer fees, and it doesn’t preclude senders from continuing to use traditional channels in cases where family and friends still need cash.

You’re probably wondering how this can work from a business standpoint. The trick is that this new revenue model relies on commissions from the retailers for the originated gift vouchers, rather than fees to customers. These merchants are often willing to pay the commission in order to reap the benefits of captured spend, sales lift, more efficient inventory management and guaranteed payments.

The other benefit of these models is that they typically avoid traditional anti-money laundering (AML/CFT) and “know your customer” regulations which can have very expensive compliance costs. Those policies are intended to prevent money laundering and terrorism financing – but such concerns don’t apply to contexts of small-value transfers to “closed loop” instruments redeemable only at retailers, and not for cash. Practically speaking, this means that startups just getting into this space do not need to apply for expensive money-transfer licenses and are therefore able to bring their products to market much faster than “traditional” new entrants to the remittance space.

The innovations in this space are exciting, but there are still a number of unanswered questions with these business models:

  • Will consumers continue to value cash over cheaper but restricted closed-looped alternatives?
  • Will senders change habits entirely or bifurcate their transfer activity (i.e., part in cash, part in directed remittances)?
  • How will receivers react, considering these models typically swing the control dynamics of the remittance relationship in favor of the senders?
  • Will enough merchants see value in the model for it to scale? Will the closed-loop redemption eventually expand from a single store to a network of retailers?
  • Will the directed remittance model purview move beyond consumptions goods to investment goods (e.g., education, housing and health care)?

Ultimately, though, the biggest question is: Is this a breakthrough for the traditional remittance model?

There are a number of ways this could play out, but given the potential economic implications for consumers created through the substantial reduction of the transaction costs paid for remittances, this is a concept that merits continued experimentation and monitoring.

Nate Gonzalez is an investment officer with Accion Venture Lab.

Financial Inclusion
Accion, financial innovation, financial products, poverty alleviation, remittances