M-Banking in Developing Markets: Regulatory Implications of Two-sided Networks WORKING PAPER FEBRUARY 2009 Professor Jamie Anderson TiasNimbas Business School University of Tilburg The Netherlands j.anderson@tiasnimbas.edu I. Introduction Infrastructure, services or products that bring together groups of users in two-sided networks are platforms. They provide infrastructure, technologies and protocols that facilitate the two groups transactions and can take many forms. In some cases, platforms depend upon physical products, as with consumers credit cards and merchants authorization terminals. In other situations, they provide physical locations or services, like shopping malls or online auction sites such as ebay. M-Banking involves the use of a mobile phone or another mobile device to undertake financial transactions linked to a client s account. M-banking is one of the newest approaches to the provision of financial services through ICT, made possible by the widespread adoption of mobile phones even in low income countries. Emerging Mobile Banking (M-Banking platforms) in developing markets enable two sided networks, bringing together mobile handset users with other mobile users and commercial partners. II. Understanding Two-sided Networks Transactions in two-sided networks involve a triangular set of relationships. Two user groups the network s sides interact with each other through one or more intermediaries called platform providers. A platform embodies an architecture a design for products, services, and infrastructure facilitating network users interactions plus a set of rules; that is, the protocols, rights, and pricing terms that govern transactions. Two-sided networks exhibit two types of network effects: A same-side effect, in which increasing the number of users on one side of the network makes it more valuable to users on the same side; and a cross-side effect, in which increasing the number of users on one side of the network makes it more valuable to the users on the other side. M-Banking solution, such as Smart Communication Inc s Smart Money or Safaricom s M-PESA clearly demonstrate same-side and cross-side dynamics the more consumers using the solution on one side of the network, the more valuable to consumers on the same side of the network as well as increasing value to users on the other side. In turn, the more commercial outlets on the cross-side of the platform, the more attractive to customers on the other side. Two-sided networks can be found in many industries, sharing the space with traditional product and service offerings. However, two-sided networks differ from other offerings in a fundamental way. In the traditional value chain, value moves from left to right: To the left of the company is cost; to the right is revenue. In two-sided networks, cost and revenue are both to the left and the right, because the platform has a distinct group of users on 1
each side. The platform incurs costs in serving both groups and can collect revenue from each. The two groups are attracted to each other. III. Two-sided Markets and Winner-Take-All Outcomes With two-sided network effects, the platform s value to any given user largely depends on the number of users on the network s other side. Value grows as the platform matches demand from both sides. In traditional businesses, growth beyond some point usually leads to diminishing returns: Acquiring new customers becomes harder as fewer people, not more, find the firm s value proposition appealing. But in two-sided markets, returns increase as the user groups grow. Many two-sided network industries are served almost entirely by a single platform. In some cases, just one company controls this closed platform, as with ebay s auctions or Microsoft s Windows. In other cases, multiple companies share an open platform, as with DVD and email standards. These two examples represent: Closed standards Used within the firm, and details and technologies are not released or shared. Open standards Details are released to third parties so that they can develop complementary or interoperable products, services and technologies. Coping with platform competition in two-sided networks is a two-step process. First, regulators must determine whether networked markets are destined to be served by a single platform. When this is the case, the second step deciding whether to allow platform monopolies (typically closed standards); to regulate for multiple platforms (closed or open standards); or to regulate for interoperability (open standards). The stakes are much higher when a networked market has room for fewer rival platforms. A networked market is likely to be served by a single platform when the following three conditions apply: 1. Multi-homing costs are high for at least one user side. Homing costs comprise all the expenses network users incur including adoption, operation, and the opportunity cost of time in order to establish and maintain platform affiliation. When users make a home on multiple platforms, they increase their outlays accordingly. For example, the vast majority of PC users rely on a single operating system almost always Windows because using multiple operating systems is expensive in terms of the additional hardware, software, and training required. Similarly, the effort that consumers must invest to build their personal profiles on social-networking sites such as MySpace limits the number of social networking sites in different countries. When multi-homing costs are high, users need a good reason to affiliate with multiple platforms. Markets tip when one standard becomes the preferred choice of nearly every consumer. ASSESSMENT OF M-BANKING: M-Banking solutions such as Safaricom s M-PESA or Smart Communication Inc s Smart Money demonstrate multi-homing costs. Consumers need to register for the service, learn how to use the solution, and cannot use different M-Banking services from the same handset without changing the SIM Card. A similar multi-homing cost applies for the cross-side of the network, with firms that interact with M-Banking clients needing the capability to interact with the platforms of different operators. 2
2. Network effects are positive and strong at least for the users on the side of the network with high multihoming costs. When cross-side network effects are positive and strong, those network users will tend to converge on one platform. A small-scale platform will be of little interest to users unless it is the only way to reach certain users on the other side. The odds of a single platform prevailing also increase when same-side network effects are positive: for example, when users of a software program need to share files with one another. ASSESSMENT OF M-BANKING: M-Banking solutions in developing markets demonstrate strong crossside network effects that are strong and positive. Consumers are most attracted to the platform that has the highest number of other consumers with whom they can transfer airtime credits or money, and it is the only platform that they can use to reach commercial partners on the other side of the network. This effect is significant in a market like Kenya where Safaricom has an 80% consumer market share, thereby creating by far the most attractive cross-network effect for potential commercial users of the system. A new entrant, such as Zain Kenya s proposed Zap platform, offers much smaller scale (Zain Kenya has approximately 18% market share) and is thereby less attractive to potential users on both side of the platform. 3. Neither side s users have a strong preference for special features. If certain users have unique needs, then smaller, differentiated platforms can focus on those needs and carve out niches in a larger rival s shadow. American Express, for example, earns high margins despite having issued only 5% as many credit cards as Visa. American Express cards have no preset spending limit a valuable feature for business travelers, made possible because cardholders must pay their full balance every month. Visa cannot match this feature, because the loans it extends to cardholders put an upper limit on their spending. In cases where special features are not important, however, users will tend to converge on a single platform. The High Definition (HD) DVD industry meets these three conditions. First, multi-homing costs are high for consumers because it would be expensive to buy multiple HD DVD players. Likewise, multi-homing costs are high for studios: Having to provide the same content in multiple incompatible formats would increase inventories and distribution costs. Second, cross-side network effects are strong for both sides of the network. Most consumers value access to a wide variety of titles, and studios realize scale economies when they can sell to more consumers. For these reasons, the HD DVD market was bound to be served by a single platform Blue Ray. ASSESSMENT OF M-BANKING: In developing markets, M-Banking is targeted primarily at the un-banked segments of society. These segments have a core requirement for basic features: airtime recharge, airtime transfers between subscribers, micro-payments for goods and services, current account facility and cashwithdrawals. Indeed, in most markets there are regulations that prevent M-Banking solutions going beyond these basic services due to the complexity of laws related to the banking sector, and due to concerns related to money-laundering. This would tend to suggest that there is limited scope for late-entrants to build strong differentiation based upon unique features. 3
IV. M-Banking as a Two-sided Network: Regulatory Implications From a regulatory perspective, it is apparent that M-Banking in developing markets has the potential to tip towards a dominant platform, especially in situations where a proprietary platform is launched by an established mobile network operator that already has a dominant market position. M-Banking platforms such as Safaricom s M-Pesa and Smart Communication Inc s Smart Money platform demonstrate multi-homing costs for users, with strong and positive network effects for both sides of the platform network, and with users not requiring unique or special features. Indeed, banking regulation typically prevents the development of unique features by M-Banking platform providers. With two-sided network effects, the platform s value to any given user largely depends on the number of users on the network s other side. Value grows as the platform matches demand from both sides. In a market such as Kenya, Safaricom s near 80% market share provides strong network effects in its existing mobile voice business, and M-PESA strengthens this further by introducing cross-network effects for consumers and commercial users of the platform. From a first-mover perspective, as demonstrated by Safaricom in Kenya and Smart Communications Inc. in the Phillipines, there is a strong incentive to maintain proprietary control of a platform in a two-sided network, especially if the owner of the platform already has significant market share in the existing mobile market for voice and data services. Proprietary control promises the potential for monopoly profits once rivals are vanquished, and further strengthens the network effect in the existing voice-data market due to the existence of multi-homing costs for consumers. There are therefore two key issues for the regulator: 1. Monopoly Outcomes: Proprietary control of an M-Banking platform provides the opportunity for an operator to extract monopoly profits if the industry tips towards a winner-take-all outcome. While government might have an objective to reduce the number of un-banked members of society, it needs to question whether monopoly control of an M-Banking platform is in the best interests of consumers. 2. Spill-over Effects: If an M-Banking platform becomes dominant in a winner-take-all outcome, this can have spill-over effects for the wider mobile telecommunications sector. Due to the multi-homing costs of using multiple M-banking platforms, switching costs are increased for consumers considering moving from one mobile network operator to another. This can further strengthen the dominant market position of a high market share operator such as Safaricom in Kenya, increasing the barriers to entry for competing operators. To avoid monopoly control and spill-over effects to the wider mobile communications sector, the regulator can pursue a number of approaches: 1. Regulate interoperability of M-Banking platforms between operators based on industry standards: This significantly reduces the risk of monopoly dominance by the first-mover, and minimizes spill-over impact on the competitive dynamics in the wider mobile telecommunications sector. 4
Even those firms that have a chance of gaining dominant market power stand to realize benefits from sharing. First, the total market size will be greater with a shared platform, and secondly a battle for dominance in a two-sided network can delay wider adoption by the un-banked due to confusion about M- Banking platform proliferation. 2. Permit the entry of competing M-Banking platforms: The regulator can facilitate the entry of competing M- Banking platforms, as was the case with Globe s G-Cash in the Philippines. But if network effects are already strong and positive for the first-mover, late entrants with small scale can find it extremely difficult to compete with the established platform. Multi-homing costs can reduce the incentive for consumers to adopt second or subsequent platforms, and the proliferation of multiple but incompatible platforms can also retard the rate of wider adoption of M-Banking services as consumers wait to see which platform will dominate. 3. Permit shared platforms for operators with smaller scale: Even if the regulator decides not to drive standards-based interoperability between all operators, interoperability should be permitted for operators with smaller market share. In the presence of network effects that are strong and positive, M-Banking platforms with the potential to reach only limited numbers of users will face significant barriers to growth. Allowing smaller operators to offer an inter-operable platform can increase network scale and provide a viable alternative to the dominant operator s M-Banking solution. This is particularly true in developing markets with three or more mobile network operators, such as Bangladesh, Kenya, Nigeria, Pakistan and India. References Brian Arthur (1994) Increasing Returns and Path Dependence in the Economy (Ann Arbor, MI: University of Michigan Press). Thomas Eisenmann, Geoffrey Parker, and Marshall W. Van Alstyne (2006) Strategies for Two Sided Markets, Harvard Business Review. October Michael Katz and Carl Shapiro (1994) Systems Competition and Network Effects, Journal of Economic Perspectives, 8/2 Carl Shapiro and Hal R. Varian (1998) Information Rules: A Strategic Guide to the Network Economy. Boston, MA: Harvard Business School Press. Carl Shapiro and Hal R. Varian (1999) The Art of Standards Wars, California Management Review, 41 (2) 5