Lessons Learned

Today was my last day at HBD. In the end, I had a good experience in my internship, learning about investing in businesses in Africa and gaining an understanding of certain industries, which should be useful in my career in the future. I had a conversation with somebody from the World Bank yesterday and she asked me about how my experience had been and what I thought I had learned from working in South Africa. I hadn't thought about it much until just then, but this was my response.

Because a segment of the population in South Africa has high education levels, it makes sense to seek out entrepreneurs with ideas to create meaningful businesses. HBD is one of the few true venture capital firms in South Africa and probably the rest of Africa as well. However, most of the products and services that these entrepreneurs offer are not suited for markets in Africa. Instead, they usually look to the U.S. or European markets as places to eventually scale up in their business plans. This means that these products and services that the entrepreneurs are developing are not necessarily going to benefit the people living in Africa, but rather those living in developed markets.

Therefore, from my perspective and understanding, VC in Africa is really an outpost for talent and ideas to bring back to the developed markets. In otherwords, VC in Africa is just an extension of the bigger developed markets of the U.S. and Europe and not necessarily an integrated part of the African markets. This model seems to be useful for HBD VC, but wasn't necessarily what I expected when I came here.

I imagine the private equity markets might be a different story, since they invest in companies in more mature industries that may have a footing in African markets, such as retail and real estate. But my goal was to understand how entrepreneurship in high growth companies in Africa might spur growth in the rest of the economy, and I haven't seen too much evidence of that as of yet.

Dial 'M' for Mobile Payments

During my time at HBD Venture Capital, I’ve looked a lot at the mobile payments industry. One of HBD’s portfolio companies is Fundamo, a mobile banking and payments service provider, which works with financial institutions and mobile phone operators to create products and solutions in the mobile payments space.

The growth of mobile phones is recognized as one of the few success stories in Africa. Industry watchers mostly attribute the growth of mobile phones in Africa to a lack of infrastructure, creating the demand for communication systems based on mobile technology. The prevalence of mobile phones has already surpassed the prevalence of computers and the internet in Africa. Prepaid cost structures and cheap phones produced by handset manufacturers make mobile devices affordable for the poor. Some even argue that mobile phones could help alleviate poverty by providing the poor with access to services. For example, fishermen are able to use their mobile phone to get pricing information from local markets, creating a better match-up between supply and demand and more profit for the fishermen. See this CNN article for more coverage on the mobile phone boom in Africa.

Therefore, there is a lot of hype over the mobile payments industry and there are several key companies that play in this space. However, because the mobile payments industry is pretty much in its early stages, it is hard to figure out what technologies are hype and what will become the enduring standards. Here is an overview of the industry and where I think it is going:

First thing that is confusing is the terminology. Mobile payments, mobile banking, mobile finance, what does it all mean?

• There are three different categories of products and services your phone can provide: mobile banking, mobile payments and mobile commerce. These services can also be called mobile transactions.
  
• Mobile banking is basically internet banking services extended to the mobile device, such as checking your account balance and paying bills.
  
• Mobile payments includes any products and services for use by the mobile phone to make payments or facilitiate transactions. This includes wallets, domestic transfers, cross-border remittances and proximity payments. None of these technologies are standardized and there is a lot of debate to which ones will take off and which ones will flounder.
  
• Mobile commerce is a catch-all term that includes anything from coupons, advertising, to ticketing (imagine swiping your mobile phone to access the subway system or to fly on a plane).
  

Who are the major industry watchers?

• From what I could gather, the Yankee Group and Juniper Research are the two main authorities for research on the industry. You will find some information on their websites, however most detailed reports costs a lot of money.

What is the current market size and/or growth potential?

• Your guess is as good as mine. Yankee Group and Juniper Research attempt to estimate this, however, even their own estimates vary wildly from month to month. However, the growth of mobile transactions should mirror the growth of internet commerce and its trends (with an obvious 5-year lag). If we were to characterize growth in three stages, emergence, explosion and ubiquity, internet would be coming out of its explosion stage and into its ubiquity stage, whereas mobile would still be in its emergence stage. One thing is for certain, growth is inevitable.
  

What are the "hot" techologies in the mobile payments space?

• NFC or "Near Field Communication" is the use of RFID technology to create a proximity payment solution. What this means is that you will be able to pay for a good at a merchant by swiping your mobile phone in front of a POS terminal, instead of having to take out your debit/credit cards. Only problem with this is that there is a significant amount of capital investment required for this system to be fully implemented. However, a large retailer such as Wal-Mart, fed up with paying fees to Visa/Mastercard, may decide to implement such a system.
• International remittances is a $318billion market currently dominated by MoneyGram and WesternUnion. Due to the ubiquity of mobile phones, even in poor migrant communities, the international remittances solutions may be a big market for mobile payments.

What are the biggest concerns or risk factors for the industry going forward?

• Since the industry is still in its early stages, there is still much need for the standardization of technologies. For example, will the use of SMS to transfer funds be the dominant mode of payments. Or will NFC-enabled devices take off?
• Business model and revenue sharing issues still pose a big challenge for the industry. For example, how will financial institutions and mobile phone operators work together to create a workable business model where both parties benefit.
• Financial regulations of financial transactions, especially cross-border transactions, require legal knowledge and the ability to work with and educate regulators from various countries.

In conclusion, the mobile banking and payments industry presents an attractive opportunity for entrepreneurs, and a possible interesting and innovative way to serve the unbanked in the developing world. Growth is inevitable, although there are certainly a number of challenges that need to be overcome in order to realize this growth. A successful entrepreneur in this space will have the technical expertise and marketing ability to convince consumers to adopt their products and will also have the ability to manage the complicated external environment and various players in the supply chain.

Calculating Market Size

I read an interesting article about how although Belgium has about the same number of internet users as South Africa, the size of the internet advertising market is $236m vs. $30m in South Africa. With a population of over 47m people, $30m seems dismal compared to other countries and one might interpret this as large market potential.

However, the number of tax payers in South Africa numbers only 4.6m. Many firms that estimate South Africa's market potential miscalculate by basing it on its population or by extrapolating per capita GDP times population. However, when calculating market potential in South Africa, one must be cognizant that South Africa has a 50% poverty rate and a seriously polarized society. One cannot simply use metrics used in the U.S. or Europe to calculate market size in South Africa.

The Land of Opportunity

The idea of doing business in Africa is often met with critics and predictions of doom and gloom due to its unfavorable environment. Political instability, conflict, red tape, corruption, inadequate infrastructure and disease are often cited for reasons why you should not invest in Africa. The World Bank issues an annual Doing Business report that shows countries in Africa on average are some of the worst places in the world to do business, and the region with the lowest growth in reform to promote business.

However, there are examples of successes that show that opportunities exist in the vast continent of Africa. For example, mobile phones have been suprisingly profitable. An article in the Economist, Africa Calling, dicusses how Mr. Michael Joseph of Safaricom, took over a company in Kenya with 20,000 customers in 2000 and grew it to a business with 10.5 million customers today. His boses at Vodacom (controller of Safaricom) predicted the market would top out at 400,000 customers. They were off by an order of magnitude and Safaricom recently made an annual profit of $223.7 million.

Graham Mackay of SABMiller is also very optimistic about opportunities in Africa. Expansions of breweries into places like Uganda have been very successful. With interests in 29 African countries and investments of $2.4 billion, SABMiller is one of the largest investors in southern Africa. Mackay says, "If there was any more of Africa, we'd be investing in it." Since 40% of the economy is informal, local knowledge is extremely important. Investing in Africa requires a different set of skills, argues another article by the Economist, Different Skills Required. Business managers cite as the most common constraint on doing business, complicated logistics, poor infrastructure, abundant red tape, shortage of skilled labor and HIV/AIDS.

All businesses face challenges. And as the article in the Economist argues, some require a different set of skills. The set of skills vary depending on the type of environment and industry your enterprise resides. A large corporation in the U.S. will have developed a set of complex skills useful for operating in places with a strong rule of law, developed free markets and formal institutions. These type of organizations are not well-equipped to deal with a complex external environment and informal institutions in places such as Africa. However, I would argue that opportunities exist for an organization that is highly flexible and is primarily focused on developing core competencies such as local knowledge and working with informal networks.

Placing businesses into buckets of categories based on the type of challenges they face that is core to their success, I would place them into the following categories:

INNOVATION

• high growth industry
• heavy investments in technology or R&D
  
• business friendly environment with little or no government intervention and regulation
• on the technology frontier
• access to high skill labor
  
• i.e. Apple and Intel

SCALE

• mature low but steady growth industry
• business friendly environment
• drive profit by cost-cutting and/or increasing scale
• access to high skill labor
  
• i.e. GE and Kraft
  

ADOPTION

• transitioning business environment
• adopt global business practices and technologies to a new environment
• some access to mid to high skill labor
  
• government intervention and regulation, although business friendly
• i.e. Lenovo and Genpact
  

PIONEER

• unfavorable or conflictual business environment
• significant resources dedicated to adopting global business practices and technologies to a new environment (discovery costs)
  
• limited access to mid to high skill labor
  
• high degree of government intervention, regulation, rents
  
• i.e. Safaricom and SABMiller
  

In conclusion, every business focuses on building a skill set appropriate to the type of challenges they face. This is no different for a business that operates in highly unfavorable business environments such as Africa. It is erroneous to believe that you cannot do business in Africa. Instead focusing on on developing the appropriate skillset (i.e. lowering discovery costs, interconnectedness with government, utilizing informal networks and so forth), could yield a vast continent of opportunities for the right players.

Note: Criminal organizations effectively utilize informal networks. More on this in a later blog.

How Much Does Your Gov't Spend on You?

Some of my colleagues will be working in governments such as Southern Sudan, Liberia and Cape Verde to promote development. I charted the government expenditures for our respective countries per capita and in total (let me know if my numbers are inaccurate).

Liberia clearly has the smallest budget in both total and per capita terms. With $27 per person, the government of Liberia has to rebuild the country from scratch, having experienced two civil wars as recently as 2003. With $27 per person, the government of Ellen Johnson-Sirleaf is charged with rebuilding roads, developing a modern health care system, providing clean water and food distribution infrastructure and providing education and social programs. They have a big task ahead of them. Good luck Team Liberia!

2002: A Space Odyssey - Mark Shuttleworth

In 2002, Mark Shuttleworth became the first African in space, as a participant aboard the Russian Soyuz TM-34 mission, paying approximately $20 million (USD). Besides his interest in space, Mark is actively involved with the development of open source software and other internet technologies, including ownership of Canonical, the commerical sponsor of Ubuntu, a free Linux-based operating system. He founded Thwate in 1995, which specialized in digital certificates and internet security. He then sold it to Verisign in 1999 for about $575 million (USD).

In 2000, Mark started HBD Venture Capital, a fund to invest in startups and entrepreneurs in South Africa. With a $150 million (USD) sized fund, HBD has about 11 portfolio companies, in the media, telecom, internet and retail industries. HBD is one of very few venture capital firms in South Africa. He also created the Shuttleworth Foundation with the aim of driving social innovation in education.

Dreaming with BRICs

For one of my first projects at HBD Venture Capital, I completed a study of trends in the private equity and venture capital markets for the BRIC countries. BRIC stands for Brazil, Russia, India and China. A research report by Goldman Sachs in 2003 argues that the BRIC nations will overcome the G6 nations in GDP by the year 2050. The paper outlines the growth projections underlying its thesis and argues that China and India will become the dominant global suppliers of manufactured goods and services and Brazil and Russia will be the dominant suppliers of raw materials.

Although I agree that the economies of the BRIC nations will be a force to reckon with, there are a lot of factors that need to be overcome in order for the projections to hold. For instance, the World Bank issues a ranking of “Doing Business” for all the countries in the world. Singapore, New Zealand and the U.S. are ranked in the top 3, while the Democratic Republic of Congo is ranked last of 178 countries. Brazil, Russia, India and China are ranked 122, 106, 120 and 83, respectively. The ranking is done on a number of indicators, such as:

• Indicator: ranking of Brazil, Russia, India, China
• Starting a business: 122, 50, 111, 135
• Dealing with licenses: 107, 177, 134, 175
• Protecting investors: 64, 83, 33, 83
• Enforcing contracts: 106, 19, 177, 20

In other words, the World Bank study supports the argument that there are a lot of improvements that need to be made before the economies of the BRIC nations can sustain long-term growth.

A summary of trends in the private equity and venture capital markets for the BRIC countries:

Brazil

• Second wave of growth after the 1998-2002 financial crisis, spurred by improvements in legislation and policies to reduce legal and credit risk to promote long-term investment, and not attract the volatile and speculative capital inflows of the 1990s which led to the crisis
  
• One of the 10 most entrepreneurial countries according to the Monitor Group

Russia

• Strong government influence on supporting innovation sectors (i.e. state-supported funds such as $1.2bn Russian Venture Company created in 2007 and focus on technoparks, technology transfer centers and special economic zones)
• Technology sectors still in early stages (IT sector relatively new and older scientists/academia not familiar with commercialization of technology)

India

• Crowded PE/VC market (over 300 funds in India with another 60+ being raised)
• Wider sector coverage (most VC deals in 2007 were in IT/BPO sector, however a lot more deals in engineering services, medical devices and energy in 2008)

China

• Uncertain legal environment due to changing property and operating laws (exit opportunities in stock market and overseas markets unclear and state still a large stakeholder)
  
• Most VC deals in 2008 were in internet and media sectors.
  

Doom and Gloom or A New Era of Growth for South Africa?

Yesterday, it was announced that South Africa’s GDP growth fell to about 2%, the lowest it’s been since 2001. Inflation, which has been steady at 2-4% for the past 5 years, is hovering above 10%. Amid fears of inflation, the South African Reserve Bank is considering raising interest rates by 200 basis points above its current rate of 15% (prime rate). With 25% unemployment, 50% of the population living under poverty and 22% HIV/AIDS prevalence rate, there is list of problems the South African economy faces. The recent spate of xenophobic attacks on foreign immigrants is adding to this list of problems. Refugee camps are springing up and creating a new class of disenfranchised South Africans.

Yet there is optimism for hope. South Africa is a well-endowed country due to extensive infrastructure and institutional development during its colonial and apartheid period. There are certain aspects of society here that place it on par with the rest of the industrialized world. It is in a position to be a gateway for channeling the vast natural resources from the African continent to the rest of the world. There is excitement surrounding the upcoming 2010 World Cup, although South Africans are concerned the construction projects will not be completed in time. In the end, if the government of South African can manage to promote trade routes with its neighboring countries and continue its track record of promoting business and growth in the country, there is potential for growth to continue.