Remarks by Vinod Khosla General Partner, Kleiner Perkins Caufield & Byers
Global Business and Global Poverty Conference
Stanford Graduate School of Business
It gives me great pleasure to introduce Vinod Khosla. He holds a bachelor's degree in electrical engineering from IIT, New Delhi. He holds a master's degree in biomedical engineering from Carnegie Mellon and an MBA degree from the Stanford Business School Class of 1980. By the time Vinod was 27 years old he had founded two companies. He was the co-founder of Daisy Systems, which was an early CAD provider, and he was a founding CEO of Sun Microsystems. Shortly thereafter he joined Kleiner Perkins and since 1986 he's been a partner at Kleiner Perkins, as most of you know, one of the world's premier venture capital firms.
During this time he's funded and served on the board of many companies. He's been a trustee of Carnegie Mellon University. He was one of the founders of Indus Entrepreneurs, a not-for-profit global network of entrepreneur professionals founded in 1992 to cultivate and nurture ecosystems for entrepreneurship and developing market economies and the emerging countries of the world. He regularly lectures at the GSB. He is the lead investor of a small company formed a year ago called Ignite that is providing very cheap solar power to developing countries.
Recently he has undertaken the study of micro-credit organizations in India, and I think that is what he is going to speak to us about today. So please welcome Vinod Khosla.
Remarks by Vinod Khosla
I am going to speak on a topic that I think is very, very important, but don't know that much about. I got involved in it probably two or three years ago, and so I sometimes say I am still trying to get my bachelor's degree in micro finance. But I think it is an important phenomenon and it's worth talking about. In fact, I think it is so important, I can't think of an economic phenomenon after capitalism that is more important than micro finance, and that's why I think it is important to talk about it, learn about it in business school and it's important because it has the ability to have a huge impact. I can't think of very many other phenomena that can have that kind of impact.
Let me start with a story. In about 1993, many of you know, I went to India and spent about half my time there looking to see if something could be done about global poverty, and if there were interesting mechanisms to leverage that. This is the kind of picture I saw [shows slide], and to be honest, my wife and I were purely despondent after that because it felt overwhelming. It felt that very little could be done. You couldn't really make a difference. It was like bailing buckets of water out of the sea or an ocean. But at the same time a small organization called Share MicroFin Limited was starting with the same picture. This was Udaia Kumar's first inspiration to start a small micro finance organization.
What he has done in the process is from 1994 through March 1999 he grew to 14,000 people, but his active clients today are 197,000. More importantly, he was doing $50 and $100 loans in villages that are generally 40-50 kilometers apart from each other, so even traveling there is a problem. He has been able to build on about $2 million of equity of one sort or another and about an $18 million loan portfolio, reduced his cost of lending to about 7 cents on the dollar, to the point where he has financial self-sufficiency of 110 percent—which in our terms means he makes a 10 percent profit counting all these expenses. When all these organizations refer to financial self-sufficiency, they adjust for the cost difference between market rates and any sub-market loans they may have gotten. You often hear terms like operational self-sufficiency, where they don't refer to the difference between subsidized loans they may have gotten. But on strictly commercial terms, with almost nothing he has grown the bank to almost 200,000 clients, and made a profit at it. And because he has made a profit at it this is a scaleable phenomenon, he can keep doing it. He has expanded to three states, 128 different branches, serving about 3,000 villages, and he has visions like any entrepreneur of expanding to all the other states around here.
More importantly, he is dreaming about a million clients. Now there aren't that many banks with a million clients, but he expects he will achieve it and he is applying to achieve it in five-years, and when you talk to him he says that if I didn't have constraints on borrowing capital, I could reach this in two or three years. That's what's exciting and that's what makes this scaleable and the equity he needs is peanuts. I can't imagine that this as a commercial entity won't be worth, with a million clients, a lot more than a few million dollars; in fact, I know it will be.
So this makes sense. Even though it's done for good purposes, it makes sense as a financial business. He's targeting the poor and, though the World Bank defines the poverty line at about $30 per month, or at about $1 per day, he's lending to people that make $7 or $8 per month, about a fourth of the poverty line, and he is having a real impact. The impact is the difference between the house on the left and the house on the right—same person a couple of years later, and you can really see how much of a difference it makes. The very poor become moderately poor and some of them become not poor by World Bank standards. That is very exciting to me.
More importantly, if you go there and talk to these people they're empowered. Most of the lending is to women, well in excess of 98 percent in this case, and what was surprising to me when I was there is I could look at a women who had borrowed and tell you how long she had been borrowing for, because anyone who had been borrowing for more than three years looked me straight in the face, eye-to-eye. People who were first-time borrowers were always looking down, their head covered with a sari, they were not empowered. But a few years of this of this not only changed their financial status, but also changed their mental attitude. To those of you who have lived here in the Valley, entrepreneurship is all about self-confidence. I have no doubt in my mind that this will have all kinds of other consequences. What was shocking was that almost all their children were going to school and that was their highest priority. Many of them, even though they didn't have food, were taking income to get private tutors because the government schools weren't good enough. But this can be done at a larger scale; it's not just 100,000 to 300,000 to a million. Professor Yunus, shown here [shows slide], had the bank with three and a half million borrowers, a total of a little more then 4 million dollars lent over the course of the history of the bank. Much more importantly, studies prove that 120,000 Grameen Bank families overcome poverty each year. Now that's powerful.
If you could replicate that, a hundred times over or a thousand times over—and I've got to believe that there's a thousand entrepreneurs like Professor Yunus among the six billion people on this planet. Only a thousand and we'd have a very different solution, so this can be done at scale. In fact, there are organizations like Grameen Foundation USA, which are partnering with young entrepreneurs in the micro finance area—Share, ASA, CFTS, SKS, and Grameen Koota. They are helping scale up to get to a million users, a million active borrowers. They are very effective in doing that and for a small amount of equity they are leveraging a lot of resourcing. They are doing this not only in India, but also in Pakistan and all over the world. Most of them were started locally. This is a whole new avenue for capital—capital on a commercial basis that's competitive with market borrowing rates so more capital can flow into this. They are also trying technology projects, and I'll come back to that a little bit later. They have an ambitious strategic plan and I encourage all of you who are interested to get more information. But even that is small scale compared to the dreams that can be dreamed here.
A number of people, Professor Yunus among them, Sam Dailey Harris was another, in 1997 convened a micro-credit summit and said at that point that they were about 4 million people or so among the poorest borrowers for the micro finance movement. And they said, "What can we do to verifiably reach 100-million poor families?" Keep in mind when they talk about the 100 million poor families or 100 million poor borrowers, it's 500 million people, because each family, or each woman supports a family of five; that's 500 million people—a half a billion people. And they dared to dream the dream of trying to reach a goal by 2005 of 100 million women or 500 million family members and to remove certain myths that it is uneconomic to lend money in $50 increments and that institutions that tried to do this couldn't be financially self-sufficient, and even if they succeeded, it would create a burden for the poor. Well, we are not all the way to 2005 and here's the result, so far. It's amazing to dream that you can impact half a billion people on this planet and it took only a few people to dream that dream, to follow through, and to make it happen. It is clearly unpathed and even if they missed the target, they will still have achieved a phenomenal thing. That's what's exciting to me. That's why I think this is one of the most important economic phenomena since the advent of capitalism and Adam Smith, and that's why I think all of you should get involved.
This is happening worldwide in a scaleable way and 100-million people are impacted in the way you see here. This is happening because a number of institutions are growing exponentionally. The number of Institutions that are doing micro finances is going up: there were 2,500 reported in 2002. Well over 6,000 institutions today are doing some form of micro finance. These 2,500 institutions, we should keep in mind, added up to, in December 2002, 67 million clients, 41 million of whom are verified to be poor by the summit. The scale and size of these institutions is growing worldwide and that's why it can be done at scale, and is not just some little village phenomenon. And it's being done on an economic basis
When I got involved, I was stunned to see the same agencies rating bank debt for commercial borrowers in India were rating bank debt for these micro-financial institutions. When I talked to them, they were brutal about it. They said I don't care that these are micro financed organizations, I don't care that they are trying to do well, I'm trying to rate them on the ability to pay back the borrowings and that makes it economic and encouraging. Share has one of the most professional boards compared to any startup we see in the Valley. They have about 1,000 employees, but what amazed me is they have 30 people in their audit function to make sure that everything is done by the book; there's no fraud. I would never have imagined a nonprofit organization (it's actually now what's called a non-bank finance company) have such a large audit function to ensure that there is no fraud, that there's no misappropriation, no inefficiency. They measure everything on market cost of funds, not subsidized funds, and every single employee has incentive compensation. Its credit officers in the field have incentive structures and comp structures that look like any salesperson in the Valley. Their base is about 30 percent of their take-home compensation. Seventy percent effect is based on the objectives of the organization, like any commercial organization.
The point I am trying to make is: Because this is not a giving kind of thing, just because you want to do good, it is scaleable, it needs orchestration, and it can draw economic resources on a worldwide and competitive basis.
Here is something on sustainability: As these organizations grow in their deposit base there are multiple agencies rating them, they've become more self-sufficient. So what you're seeing here is a sort of a pyramid scheme, but a virtuous and a sustainable one, built on pragmatic economic principles. They don't try to do everything the poor person needs. Clearly they need healthcare, clearly they need education, clearly they need training, but if you start doing all that you can't be economically profitable, you can't be sustainable and you can't scale. So, they're practical, they do the best they can, not everything that's needed, but they make sure that they're sustainable and they can grow; and they allow these people in the villages to use their entrepreneurial skills, their ideas, their need for self-preservation to feed themselves, to survive and to better themselves. Matched with the kind of appropriate capital, appropriate assistance in a commercial basis, all the features of Silicon Valley to help them.
A couple of quick words. Regulation still gets in the way. They can't take deposits from these so their lending costs are higher; they have to borrow from commercial banks. There are other kinds of regulations, and I urge all of you to get involved and help regulations to be more appropriate for this new kind of institution. These loans now have histories that have repayment rates that are better than most banks, whether in the United States or in India, yet they don't get the kind of credit they should.
I mentioned one securitization instrument that was invented. More needs to be done, is being done, and I urge all of you to look at it. It justifies commercial lending and financial international instruments and I encourage you to do that, to draw more capital to this. It is really about doing well economically while doing the right thing and doing good. Technology has a role to play. A number of institutions, MIT Media Labs and UC Berkeley, have projects in this area, so those of you who have that inclination can get involved and can leverage the kinds of services that can be offered. There is many a debate on it, but I have to say, those debates are academic. You know, whether somebody is really making $7 per month or $30 per month, which is the official poverty line, or $45 dollars a month is really irrelevant. When you go back and visit them they are so desperately poor that I don't want to get caught up in those debates. I want to take every penny of resources we can to help these entrepreneurs and let's not be academic. Large institutions are doing good impact assessment studies, but sometimes I feel more money is going into research programs, into impact assessment, than into helping the poor. There are debates about whether these interest rates are too high; they charge interest rates between 20 and 30 percent to the poor, but if there weren't a market mechanism, would you rather have no loan or interest at 25 percent? The alternative is generally the local moneylender who charges 5-10 percent per day, not 20 percent a year; so let's be pragmatic, let's get beyond superficial, ethical dilemmas and use some of the lessons we have learned here and harness that same power to really make an impact and really put more engine behind one of the most exciting economic phenomena.
Let me stop there and open it up to questions.
Question: You may "have a bachelor's degree in micro finance," but I'm still in kindergarten. My question is what does a women do with $50? What is it exactly that they do? What's the typical success story for someone?
Khosla: I wish I had hooked up my laptop. I have about 20 slides. Let me try and define it. A little rickshaw or a bicycle so they transport the wheat they've grown to the market, otherwise they lose 50 percent of the profits because somebody else does it. If in the business of selling vegetables, they generally borrow money from the moneylender in the morning, pay 10 percent, 20 percent, 30 percent interest for the day, (for the day!) and when they come back, the moneylender charges them just enough so they can survive but not be independent. Buying a buffalo, opening up a tea stall, opening a little grocery store in the capitol; there are hundreds of little businesses.
But there are some exciting new ones to come along. There were some Internet kiosks that cost about 10-15,000 rupees—couple of hundred dollars—and they found that they became profitable within the first three months with a little bit of training. Including the cost of the training within six months they actually provided a livable wage to their owners. There are other examples. They can afford lights with micro finance and it adds three or four hours to their working day. If it's dark, without light, a solar light, something that is essentially cheap, they don't have electricity for which they can either study or build something and sell it, so it takes time out of their day. So there are lots of activities, in fact, those of us who know economic activity say you don't plan, you don't tell them what to do; it's an emergent behavior, and I refer you to the studies that say if enough people are enabled, they actually start catalyzing each other and economic activity emerges in surprising ways.
Question: To follow up on just what you were speaking of, these emergent activities, what's the effect on the community as you begin to lend to individuals in the community? Does it spread? Do they see these ideas, and does the lender actually get in to promote the concepts that you talked about, that you can do this, you could change your supply chain. How active do they get in promoting business ideas?
Khosla: If I understand the question: What role does the lender play? Now in the community there is often a vested interest in keeping the old structure, so the village moneylender really generally hates it. There are farmers who think they can't get enough labor because some of these people are developing alternatives. So there is an infrastructure that opposes this, and this is by no means easy. By and large, the borrowers spread the message. There is actually a pyramid scheme: They don't lend to one lender-borrower; they lend to groups of eight that provide insurance for each other. It is a lot more sophisticated than I explained here than just lending them $50. They have groups of eight women commit and because they are part of the same community, they don't default because it is embarrassing to default and if one person defaults, the others have to make up for it.
It also is an insurance scheme because if one person falls sick or dies, there is a way for the family to pay it back, because the rest of the people are responsible. So it's a fairly intricate set of details that have been worked out to make it economic. Normally you would consider something like this uneconomic, but it really becomes a powerful tool for the community.
Question: You spoke about education programs and how with a little bit of education you can make a big difference. Could your elaborate a little more on what specifically you've seen are the efficacies of those programs and what do you think is lacking and what kind of programs would bolster this micro-credit industry?
Khosla: Well, I have seen a lot of education. I've probably personally looked at a hundred education programs in rural India at one point or another in my life. The frustrating thing is there are a lot of good programs, but they can't be scaled. There is no economic basis scaling. There are lots of people doing something for one village or 10 villages or even 30. The thing is that unless you do it on an economic basis, it can't be scaled. We need to do it for 600,000 villages, not one or two or three, and unless the system regenerates the resources, the capital resources, it's not going to work. So Share, for example, has disciplined itself to not do more than it can afford to do. It encourages it, it even works with non-profits who are trying to work with them and provide education, and what Udaia Kumar, who is the founder, wants to do is he talked about taking the profits that he's made and giving it to other organizations who can channel it. But unless you do it with profits you can't keep relying on giving to support these programs—there's just not enough in the world. Trillions of dollars will be needed over 25 to 30 years. The only way to generate those kinds of numbers is on an economic basis and to draw international capital flows on a completely market-competitive interest rate into this kind of phenomenon.