One interesting (at least to me) emerging idea for defeating poverty is to make it easier for a poor person to start a very small (micro) business.

Does microfinance have a limited market? Some of the critics of microfinance have argued that most humans (including the poor) don’t have what it takes to be an entrepreneur who can successfully start a business from scratch and then continue to grow it. The critics have pointed out how so many of the poor who take microcredit loans are starting copycat microbusinesses with low profit margins and therefore questionable sustainability. The advocates of microfinance recognize this as one of the results of a free market system where you have a bell curve of success — some are very successful, most are moderately successful and some fail. All this said, mechanisms, systems and approaches which increase the likelihood of success for a business entrepreneur are welcomed by all.

Kirk Magleby, a defeating poverty activist, has done substantial research into a way to “lower the bar” — making it easier — for the motivated poor to generate more income. He refers to this as MicroFranchising. Think about how the ubiquitous Subway franchises have sprouted up so quickly across North America … and then downsize this to the size of a stall or a very small storefront and you’ll get the idea of the “micro” version of franchising.

The reason that franchises can spread so rapidly is that the purchaser of the franchise is buying a well-proven system for setup and operating a business so they have to invent less themselves. They simply go to the training course, read the manual, pay the start-up fee, find their location and then setup the store/stall according to the manual. And, presto, they’re in business. Yes, they often have to buy products and supplies from the franchise owner (single source supplier) and they also pay them a percentage of your gross sales. But often this is a worthwhile trade as the franchisee has instant brand recognition, an operating business and many other risk factors are reduced as they follow the system and services provided by the franchise owner.

So, the idea is to “encourage” both national and international established corporations to more aggressively downsize their franchising model to enable a motivated poor person to run a microfranchise. If a franchise model is micro-sizable to a minimally educated poor entrepreneur, then the large companies should be expected to rapidly adopt this model as a lucrative new sales channel.

How would the poor person pay the upfront costs to setup the business, buying inventory, etc? Often the franchising company will over finance the setup and working capital as it is a highly profitably business for them beyond just the financing. The other most promising financing source is local microfinance institutions (MFIs.) MFIs should be very willing to finance these type of operations for their quality clients as these type of businesses have much less risk than financing a similar completely independent business. This is why I view microfranchising and microfinance to be highly complementary services.

Magleby identifies a vast number of potential microfranchising businesses including almost anything that is purchased by consumers and businesses. One example where microfranchising has been successful to date is for mobile (cell) phone franchising. Here is one Vodafone example in South Africa which Magleby references.

Further reading on Magleby’s ideas:

• MicroFranchises as the Solution to Global Poverty
• a well-presented argument for why microfranchises could be helpful
• 13 page summary version (Microsoft Word)
• full 80 page version (PDF)
• A Model to Solve Poverty
• lays out his ideas on microfranchising and solicits discussion

Please post comments on this idea and any other examples of microfranchise attempts — both positive and negative.

Update: Here’s a new blog on Microfranchising

There is a major positive change starting to ripple through the microfinance industry … the trend towards running microfinance institutions (MFIs) as for-profit businesses rather than non-profit charities. Today, The Wall Street Journal ran a front page article on this trend highlighting a for-profit Indian MFI, SKS, which I have visited in Hyderabad last October. Unitus, a microfinance venture capital non-profit, was very instrumental in enabling this new direction for SKS and is an early equity investor in SKS.

This trend is incredibly good news for the poor! Why? Here are a few reasons:

• For profit MFIs are much more likely to continue operating for the long haul … which means that they will continue to be servicing the poor when the donated funds for non-profit MFIs move on to the next interest.
• For profit MFIs are forced to operate efficiently in order to create a profit. This means that they need to create an ongoing operational efficiency culture. Over time, (sometimes even short-term) this means that the cost savings can be passed along to their poor clients in the form of lower interest rates or fees.
• For profit MFIs are forced to be more transparent with their governance. Generally, this is forced upon them by regulation and their investors who want to see how their money is being used and to reduce the possibility of fraud and mismanagement. A more transparent, healthy MFI is likely to receive better rates on loans from banks which lowers their cost of capital which over time can (and will due to competitive pressures) be passed along to poor clients.
• For profit MFIs can accept equity capital. That is, investors can buy shares in a MFI. This provides very inexpensive and flexible capital for the MFI which enables them to make forward-looking investments in staff, systems, expansion and other things which enable them to grow and expand. And, unlike loans, the MFI doesn’t have to pay back this capital or pay interest! Additionally, equity capital can be leveraged to enable them to borrow more money from banks which is then lent out to poor clients. So, the net benefit to poor clients is more loan money at lower interest rates.
• For profit MFIs are much more likely to focus on their poor clients as “customers” vs. beneficiaries. That means that they will care about things like customer service and creating financial products which work best for their poor clients in order to retain their customers over the long-term and help their customers be successful. This potentially is one of the greatest benefits to poor clients as their needs change and evolve.

What are other benefits of a for-profit vs. non-profit? What are the downsides of a for-profit? Please post as comments.