Identifying the Problems for Entrepreneurs

The entrepreneurs that Mifex will fund operate in the world's poorest economic sectors where there is high demand for financial and consulting services. To understand the effects and potential of this unmet demand it is necessary to discuss the economic environment of these entrepreneurs.

Production of Developing Economies

The macroeconomic problems of these sectors expose the microeconomic demand for the services provided by Mifex. According the commonly cited Solow growth model there are three variables that determine the output in an economy: production, capital and labor. The equation for representing the Solow Growth is the following:

Y = AK^aL^1-a

Here Y represents the total production in the economy, A represents total factor productivity or TFP, K is capital, L is labor, and 1-a is a number less than 1 (indicating that capital and labor have diminishing returns to scale).

Developing economies usually have low outputs due to two major factors: lack of capital and low productivity levels. These economies are usually labor intensive as they do not have money to invest in their businesses nor do they have access to technology that increases productivity. The levels of K and A are extremely low and result in low levels of production and poor economic segments. Therefore, capital shortages and low levels of productivity are the main societal problems that Mifex aims to resolve. In the next sections we will explore the causes of these two problems, the difficulties they generate for the economy, and the demand created by the conditions.

Problem: Capital Shortage

Developing countries suffer from severe shortages of capital. It is difficult to generate enough disposable income to be used as investment for businesses, especially in the poorer areas of these nations. A USAID market study of microentrepreneurs in Ecuador supports this notion:

"The problem is that, by relying only on internally generated funds, a firm's ability to grow is limited. Ecuadorian microenterprises, in general, do not generate large cash flows. Profits, in absolute terms, are relatively low. This shortage of cash leads to the financial problems... Expanding a business often requires more capital than it can generate internally, yet the low levels of income and profitability limit its ability to service high-cost loans." (USAID Market Study, p.85)

Investors from elsewhere are wary of these sectors due to the high risks they represent. Political instability, economic crises, vulnerability to natural disasters and a host of other issues are enough to scare away these individuals. Furthermore, they do not see the profit potential in economies where production, consumption and savings are low. Therefore, domestic and foreign investors rarely seek to fund medium and large companies in these poor sectors.

Instead very small businesses, referred to as microenterprises, dictate the pace of the economy. Due to the lack of capital and access to technology these microenterprises rarely evolve into larger businesses. Usually these businesses have low start-up costs because they are run out of the home and are small operations. Consequently, many people are able to create new enterprises but very few can make them grow. The result is the presence of a high volume of microenterprises operating in highly saturated markets and restrained by limited access to capital. Society suffers because they do not benefit from the increased efficiency, improved products and lower costs associated with the presence of medium and large businesses.

Demand and Supply for Capital

Typically microentrepreneurs attain capital for investment into their businesses through various sources: savings, sales, personal loans, informal creditors, and formal financial institutions. The bulk of their investments come from their own income (generated through savings and extra revenue from sales) and loans from family and friends.

Informal creditors are an option, especially in times when there is an immediate need for the financing. Unfortunately these individuals take advantage of the shortage in supply and charge extremely high interest rates. Therefore, microentrepreneurs generally do not borrow from these sources and prefer to wait longer to accumulate savings or seek a loan from friends and family.

Microfinance Institutions

Recently microfinance institutions have emerged in many poor countries to provide small loans to microentrepreneurs. Although they have grown at an impressive rate, there are still high numbers of microentrepreneurs that have not received financing. Furthermore, there is a growing concern that microfinance in general is not reaching the poorest segments that contain individuals in extreme poverty.

Problems facing microfinance

Ironically, MFIs suffer from the same ills as their potential clients: they also have a need for capital that can enable them to expand their services. According to Blue Orchard Finance, a microfinance investment advisor, microbankers estimate that in the next 5 years they will need between 10 to 20 billion dollars if they are to meet their projected demand. MFIs have an increasing need to finance higher volumes of loans, larger microfinance operations, and the acquisition of technologies that lower costs and facilitate outreach to poorer segments. If they do not find a source for this capital it is unlikely that microfinance will continue to grow at the current rate.

Problem: Low Productivity

The other main factor restraining growth in these economies is the low productivity. Entrepreneurs in these sectors usually have little formal education and have never been trained to run their businesses properly. Furthermore, they do not possess technologies that can make business operations more efficient, nor do they have the know how to attain these technologies.

In terms of the Solow growth model we can see that by having a low A the effects of increases in capital or labor are restrained. In fact, TFP is so important in this model that is estimated to account for 60% of growth in economies.

Therefore, if TFP does not increase, it is unlikely that capital by itself can have a significant effect on the growth of economies. It has not been able to help many entrepreneurs that operate in overly competitive and saturated markets. They lack the skills and knowledge necessary to manage and invest loans properly. Their unfamiliarity with formal finance makes entrepreneurs fear indebtedness instead of seeking investment capital. It has become evident that microfinance by itself cannot result in the complete development of these struggling economies.

Social Returns on Investment (SROI) from Microfinance

Economic Effects

In order to quantify the social returns on investment we will once again refer to the Solow Growth Model. At this point, it should be clear that the immediate effect of Mifex will be an influx of capital. Through business development and training services offered through our partners we also plan to have a significant impact on productivity. Therefore, these economies benefit from an increase in capital (K) and productivity (A). To represent the effects graphically we will use the capital labor-ratio, k, and output per worker, y. Therefore:

If k = (K/L) & y = (Y/L)
Y = AK^aL^1-a
y = A(k)^a

The following graph represents a simple model of the estimated effects that Mifex can have on an economy. An increase in A results in an outward shift of the production curve, highlighted by the red arrows. Increases in k are represented by a movement to the right along the curve. The anticipated effect of business development services will be an increase in production from A₁ to A₂ resulting in the shift of the curve. The increase in capital from our microfinance operations are represented by a movement from k₁ to k₂. The economy begins at a low level of k because there is a low capital to labor ratio. The result is a shift from point A to point B on the curves. The overall effect on the economy can be interpreted as the shift of production per worker from point y₁ to y₂.

Overall the economy of these countries should benefit from the increase in production. These increases should translate into higher incomes for the entrepreneurs and a higher standard of living for their families. Consumers benefit from the presence of larger and more efficient businesses that can provide better products at lower prices.

Social Effects

Economic development can have a significant impact on society, especially when the development occurs in impoverished regions. Microfinance provides the poor with the opportunity to change their lives forever. With the benefits from an increased income they are able to provide better healthcare, schooling and housing for their families. All of a sudden, a generation of people who would have probably grown up in an impoverished home with low levels of education can now await the future with optimism. Best of all, lenders can witness the social returns of their investment through our online reporting that includes pictures and journal entries of these families. The experience is real and unlike any other charitable option available through the web.

Perhaps the most important aspect of Mifex is its focus on strategically developing poor economies and rebuilding staggering economies. Mifex does not just fund microenterprises in poor regions like MFIs. We provide entrepreneurs with the specific training they need to use the capital wisely. We also guide these entrepreneurs into larger and more organized efforts that can create value in society in the form of jobs and production. Furthermore, we seek to build a healthy economy for these enterprises to operate in by funding projects that aim to resolve major problems in these communities. With the support of government, business and universities we work to coordinate strategic development backed by the influx of foreign capital. The Mifex method works to boost the economies of developing countries by leveraging business opportunities, innovative technologies and strategic alliances.

Cost-Benefit Analysis

The Mifex concept is interesting because it is designed to utilize all the powers of the marketplace in order to thrive. First of all, excess capital from potential investors is mobilized into developing economies through an online marketplace. Mifex funds its operations by collecting a portion of the interest charged on the loans to the entrepreneurs. Therefore, the most pressing cost of the company is in the start up phase where it is necessary to organize, train and support our team while building microfinance operations that utilize cutting edge technology to lower future operational costs.

Although microfinance is steadily making progress in the fight against poverty it is necessary to look towards complete solutions like the one offered by Mifex. We not only address capital shortages in society, but we seek to resolve other issues that hinder the growth of small businesses and have negative impacts on society. By coordinating and organizing our programs we seek to build strong communities efficiently and permanently. Furthermore, the effort to strategically invest capital from all around the world into poor economic segments through the internet represents an innovative concept that has the potential to become a powerful weapon against poverty.