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The "missing middle" of small businesses with Shamina Singh

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How fintech innovations can help small merchants realize the benefits of financial inclusion.

Rambabu sells tea in India. Like most businesses in the country, Rambabu’s tea shop is small and deals in cash. He makes about 500 cups of tea each day, charging 5 rupees per cup. But, the cash comes at a cost to him, one he could avoid if more people in India—merchants and customers alike—adopted digital payments more widely. For Rambabu, the catch is change. 

“There’s always a shortage of small change. Customers also don’t carry small coins,” he told <a href="https://www.globalinnovationexchange.org/beyond-cash">USAID</a>. To keep supplied in coins, he relies on beggars, paying them a 10% premium for their loose change. “I pay 100 rupees for every 1,000 rupees of change I buy,” he said.
Rambabu’s business is just one among thousands in the large cash-based ecosystem of micro merchants in India that could be more profitable if digital payments were more widely used. In India, <a href="https://www.usaid.gov/india/financial-inclusion-and-diaspora-engagement">97 percent</a> of retail transactions are conducted in cash or check.
A recent <a href="https://newsroom.mastercard.com/wp-content/uploads/2017/09/Mastercard_Financial-Inclusion_Merchant-Acceptance_FINAL.pdf">Mastercard report</a> outlines steps countries can take to ensure more small and micro businesses adopt cashless payments and more customers use them. Research has shown that use of digital financial services has many <a href="http://www.economist.com/node/14505519">advantages to cash</a> and <a href="http://www.sciencedirect.com/science/article/pii/S1879933716301695">spurs savings</a>. And savings for the world’s poorest is a lifeline that helps lift them out of poverty.
“Payments…can serve as an on-ramp to financial inclusion,” notes the report. “Financial inclusion provides the unbanked with an opportunity to break free from the vicious cycle of poverty by giving them access to tools that allow them to securely pay, save, borrow and insulate themselves from financial shocks.”
The chicken, the egg and the merchant
The push for digital financial services is growing. Indians have opened <a href="https://newsroom.mastercard.com/wp-content/uploads/2017/09/Mastercard_Financial-Inclusion_Merchant-Acceptance_FINAL.pdf">280 million new bank accounts</a> since 2014, when the government made a push to provide every household with a bank account. But, old habits die hard. Most Indians—and most digital account users in developing countries—continue to withdraw money from their account in a lump sum and do business in cash. In 2015, an average active mobile money user worldwide <a href="https://www.gsma.com/mobilefordevelopment/wp-content/uploads/2017/03/GSMA_State-of-the-Industry-Report-on-Mobile-Money_2016-1.pdf">made only one merchant payment</a> in the entire year.
One reason for this limited use is that few small businesses take digital payments. In India, <a href="https://www.globalinnovationexchange.org/beyond-cash">only 6 percent</a> of merchants accept digital payments, according to <a href="https://www.globalinnovationexchange.org/beyond-cash">USAID and the U.S. Global Development Lab</a>. In the absence of a significant acceptance base, digital payments have little utility and hence, there is little incentive to maintain digital liquidity, notes the Mastercard report.
Small merchants have not jumped on the bandwagon for a variety of reasons. At the core is a classic chicken and egg dilemma. When people don’t use their digital wallets regularly, per-unit costs for merchants rise. That dissuades small merchants from offering digital transactions. And with so few merchants offering digital transactions, customers resort to cash. As such, there’s little risk merchants will lose a sale to a competitor using digital payments and thus, little incentive to invest in digital.
“Merchant buy-in will lead to more digital liquidity and economic security for consumers,” said Dan Salazar, a vice president at Mastercard tasked with building out the company’s acceptance strategy for financial inclusion.
Getting merchants to go digital
The Mastercard report offers several ideas and innovations to address the barriers faced by small merchants and make digital payments more attractive and relevant to them.
Reduce upfront costs of investing in equipment and start-up. Setting up a digital payment system can be costly in both time and money for small merchants. QR solutions like <a href="https://newsroom.mastercard.com/mea/press-releases/dtb-and-mastercard-partner-to-enhance-digital-payments-in-kenya/">Masterpass QR</a> can help eliminate the upfront costs because customers use their own phones to scan a merchant’s unique QR code. Other innovations like <a href="http://www.ftcash.com/">ftcash</a> allow merchants in India to start accepting digital payments in less than five minutes.
Subsidize initial investments. In 2016, when the Indian government demonetized its currency, the government provided two point-of-sale machines for free to each village with a population over 8,000. It also capped fees for low value transactions for a limited period. Rebates are also an option to subsidize initial investments. The Indian government is considering offering a two percent discount on the goods and service tax paid on digital transactions less than 2000 rupees (approx. $30).
Expand credit: Small merchants in India typically rely on the cash from the day’s sales to buy the inventory for tomorrow’s. A line of credit could help stabilize and expand their businesses. With digital payments, banks can quickly see how well a business is doing and offer credit accordingly. Toward this end, the Center partnered with India’s Institute for Financial Management and Research to survey more than 500 merchants across the five Indian cities to better understand what solutions might best incentivize merchants to go digital. The survey looked at the business profiles in terms of cash flows and assets, credit profiles and usage of digital financial services. Among the key takeaways: enterprises experience a high-level of seasonality with their cash flows, pointing toward the need for flexible credit combined with training on how to do manage a budget around volatility. (The full results of the research will be available by mid-October.)
Make accepting payments seamless across different financial institutions. Merchants just want to sell their goods and services and accept any cost-effective payment scheme their customers want to use. As such, merchants should not have to choose between financial companies nor invest in bank-specific hardware to accept payment. <a href="http://economictimes.indiatimes.com/industry/banking/finance/bharat-qr-code-launched-to-push-less-cash-economy/articleshow/57256004.cms">Bharat QR</a>, launched in India in 2017, is the world’s first fully interoperable payment option. USAID is also <a href="https://www.usaid.gov/india/financial-inclusion-and-diaspora-engagement">partnering</a> with the government of India to create a network of more than 40 organizations to increase the use of digital payment systems among low-income consumers.
Reaching critical mass
Expanding electronic payment acceptance among small merchants is a complex, but necessary task to realize the full promise of financial inclusion. New innovations will need the support of policies and public-private partnerships for them to reach a critical mass.
“The adoption of digital payments is seeing good progress in India, yet there is still a long way to go before this transition becomes a movement,” said Praveen Khandelwal, the Secretary-General of the Confederation of All India Traders (CAIT), a leading trade group that has <a href="https://newsroom.mastercard.com/asia-pacific/press-releases/mastercard-and-cait-join-hands-to-augment-use-of-digital-technologies-among-traders/">partnered with Mastercard</a> to train more than 300,000 merchants. “The journey to less-cash requires a determined approach for all the key stakeholders—from government, banks, industry bodies and technology players.”
With 280 million new bank accounts in India, the next step will be to ensure that those citizens use their accounts in ways that foster their own climb up the income ladder. Paying for their daily shopping digitally is a crucial first step.
This story is the first in a series examining the role of merchant acceptance by small and micro businesses for advancing financial inclusion. Future stories will focus on the role of regulation, new business models and public-private partnerships in driving usage of financial services and products for underserved.
Featured Photo Credit: People waiting to exchange demonitised Indian currency/MANJUNATH KIRAN/AFP/Getty Images

Toward a Less-Cash India