Is Transparency Enough? What is Fair and Ethical in Pricing?

In this paper commissioned by the Micro Credit Summit for presentation at their 2012 Global Summit, Chuck Waterfield pulls together many of the factors that influence microcredit pricing and establishes a theory of “where the price curve starts”.

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This breakthrough on understanding why prices vary among microcredit products sets the groundwork for the industry to move toward a position on what prices we should charge the poor.

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Synopsis

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For microfinance institutions the pricing of microloan products forms a critical component in achieving the delicate balance between being financially sustainable and socially responsible. The past fifteen years have witnessed the microfinance industry move problematically towards commercialization.

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This has resulted in part from the widespread absence of understanding microloan pricing and the avoidance of ethical considerations surrounding pricing. The implications of the commercialization of microfinance need to be examined in terms of product pricing and a clear definition of responsible commercialization needs to be articulated.

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In terms of pricing, responsible commercialization is characterized by three intertwined components – the delivery costs of the microfinance institution, the product prices that institutions charge, and the investigation of the levels of prices that clients can afford. This paper examines the first of these components – the delivery costs to the institution. Two planned further papers will examine the second and third components.

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The price that is charged to the poor is an issue that reaches to the core of microfinance. This paper proposes that there is a moral obligation for the microfinance industry to address the challenge of defining ethical and responsible practice, and within that the issue of fair and ethical pricing.

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The sections of this paper address the following areas:

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Section 1: What Price we Charge the Poor – An Issue that Reaches the Core of Microfinance proposes that the microfinance industry should take on the important challenge of broadly defining ethical and responsible practice, and within that the issue of fair and ethical pricing. There is no legal obligation for us to do so, but a large number of us believe there is a moral obligation that we do so, and the sense of the general public and most governments seems strongly on the side of expecting moral behavior from businesses involved in what has through history been called usury. It defines a process for moving forward in this definition.

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Section 2: The Need for Transparent Pricing presents some foundational issues about how to define a transparent financial price, why non-transparency inhibits a market from functioning properly, and how regulators of formal finance help to correct the problem with Truth-in-Lending legislation.

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Section 3: The Price Curve Resulting from the Cost Curve provides new insight into how product delivery costs and current microcredit prices behave very differently than commonly assumed. The material gives atheoretical case for the cost curve and the price curve and then examines data from numerous MFIs and countries.

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Section 4: A New Benchmark for Operating Costs is material presented for the first time in this paper. It examines and compares product delivery cost data across countries and proposes a new generalized benchmark for assessing approximate efficiency levels of MFIs.

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Section 5: The Bind of Prices and Profits – Underlying Assumptions that Drive Current Practice then applies this deeper understanding of the costs of delivering microcredit to the industry’s standards on MFIs reaching financial sustainability. Seeing the challenges of delivering different kinds of loan products through the new lenses constructed in the first part of this paper will likely lead to more interesting and complex discussions of sustainability than we have had in the past.

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Section 6: Advancing on our Determination of Fair and Ethical Pricing then goes behind the concept of sustainability and addresses the issue of profits and degree of profits. Our profits are a result of the prices we set. There is a direct correlation between our “fair and ethical” prices and the amount of profit we make from those at the Bottom of the Economic Pyramid. Thus, we cannot get to a definition of fair pricing without examining also the issue of profits. Those MFIs who make high profits have intentionally chosen to make high profits, and they do so through the prices they set on their products.