The importance of segmenting small businesses to enable better finance
- CGAP recently published a focus note that highlights the importance of segmentation to better meet the formal financial needs of small businesses.
- This research segmented micro- and small businesses across five dimensions, yielding valuable insights on financial needs and perceptions.
- The focus note also offers recommendations for providers to better meet the financial needs of small businesses.
Micro- and small firms make up the majority of businesses and more than 50% of employment worldwide. But they continue to be constrained by limited access to finance. Access to finance is critical to small business development and growth, but there are few financial solutions that account for MSEs’ nuanced and diverse needs.
Recently, CGAP published a focus note that advocates for the importance of a segmented approach to addressing small business needs. While small and micro-businesses are often grouped together, they have a variety of business journeys, differing financial and nonfinancial needs, and different experiences using financial services. With a segmented approach, CGAP argues that financial service providers (FSPs) and others in the financial inclusion community can understand small businesses better and design and deliver more effective solutions.
CGAP’s focus note is based on primary research conducted with almost 400 MSEs in India, Kenya, and Peru, primarily from the manufacturing, retail, and transport sectors. Using online surveys, in-depth interviews, and focus group discussions, the research demonstrates the diversity of small businesses across five key and often interrelated dimensions: sector of operation, entrepreneurial mindset, growth stage, entrepreneur’s gender, and business size.
Segmenting MSEs across five dimensions
CGAP’s research segments small businesses across five dimensions, with insights that can help FSPs better understand and serve them.
1. Sector of operation: A small business’ choice of sector is shaped by the entrepreneur’s gender, socioeconomic status, motivation, and ability to access productive assets. For instance, entrepreneurs with high socioeconomic status are more prevalent in the transport and manufacturing sectors, while entrepreneurs with low socioeconomic status prefer the retail sector because it is quick to start up and requires lower asset investment. Sector of operation also influences capital needs, formal finance sources, and digital readiness (see figure).
2. Entrepreneurial mindset: This research identifies two types of mindsets that affect a small business’ trajectory: cautious entrepreneur and determined aspirant. Cautious entrepreneurs are focused on stability and immediate livelihood goals. They exhibit a low-risk appetite and tend to be reluctant to scale, formalize, and embrace new technologies. They also prefer informal finance sources and are hesitant to use credit products. Determined aspirants are focused on growth, building a safety net, and fulfilling ambitions. They exhibit a high-risk appetite with plans to scale, and they seek out new technologies to solve their business needs. They’re open to using formal finance sources over time, as long as they are relevant and create value.
3. Growth stage: Small businesses experience at least three stages in their lifecycle, including the start-up stage, the stable operations stage, and the growth stage. This isn’t a linear journey, and small businesses may move between these stages multiple times. Family and friends are often the only financing option in the start-up stage. Even when formal options exist, they cannot compete with the fast, free, and flexible aspects of informal sources. When small businesses enter the stable operations stage, their awareness of financial and nonfinancial sources of support is influenced by their peers and social networks. For growth-stage small businesses, obtaining finance from formal providers can be a slow, unclear, and unforgiving experience.
4. Entrepreneur’s gender: Gender norms play a critical role in the growth journey of small businesses. The research suggests that, while some women start businesses to support their families, many do so to achieve economic empowerment and independence. Beyond funding from family members, women entrepreneurs look to informal groups, like micro-savings groups, that have lower barriers to entry and offer networking opportunities with other women. For larger finance amounts, CGAP found that women entrepreneurs seek stability in FSPs and demonstrate a preference for providers with female representation among their staff, client base, and marketing campaigns.
5. Business size: The size of a small business is often associated with the owner’s socioeconomic status, education level, and social networks. Further, the research suggests that a business’s size may be a good indicator of preference for formal rather than informal finance. Businesses with fewer than five employees and those with up to ten employees are more likely to use informal sources of finance, such as family, friends, and social networks. Larger businesses tend to use formal finance, as their needs can no longer be met by informal sources, or they may want to retain control and privacy over business decisions.
How FSPs can better reach underserved and excluded small businesses
In addition to the insights yielded from segmenting small businesses across the five key dimensions, CGAP’s research also identified some cross-cutting themes with respect to finance. First, a strong preference for informal sources of finance remains prevalent across all MSE segments. For small businesses, informal finance offers trust, and flexibility, in addition to tailored products and services. Second, small businesses are not willing adopters of digital finance—much of the increased use is in response to customer and supplier preferences. Third, small businesses continue to remain wary of FSPs, particularly the lack of transparency on interest rates and other loan terms.
CGAP offers recommendations that FSPs can integrate when designing and delivering financial products for small businesses, including:
- Tailor value propositions for the segmented needs of small businesses. This could include flexible, customizable products and services that are aligned with business cycles; gender-specific and context-sensitive products and services for women entrepreneurs; increasing awareness of the benefits of products and services for small businesses; and embedding digital and financial literacy components into product offerings.
- Build greater trust and confidence. Small businesses have low trust in digital credit providers, with concerns about data privacy, aggressive repayment tactics, and penalties. FSPs can build trust and confidence by simplifying communication, eliminating jargon, and increasing transparency on costs, associated fees, and penalties.
- Provide greater customer support. As small businesses embrace formal finance, they seek out positive experiences, and providers can better enable these by simplifying and de-risking customer onboarding through transparent communication and trial use periods. FSPs can also develop effective customer journeys and encourage adoption by embedding new offerings into familiar products.
On the whole, CGAP’s research offers valuable insights for those supporting small businesses to grow and deepen their financial inclusion. The focus note underscores the importance of what we can learn about small businesses, their needs, and their preferences by taking a segmented approach to a group whose diversity is often not perceived by providers. Understanding the needs of small businesses is a core component of Strive Community’s programs, enabling our grantees to design useful and relevant digital products and solutions.
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