Like businesses everywhere, small businesses in impoverished nations also depend on loans—often very small loans, or microfinancing—to get off the ground. Whether it’s operating a vegetable stand, selling goat milk, or offering other merchandise, a little financial jolt from the bank helps kick-start the business. 

But when these loans are not repaid, bad things happen.

“If lenders cannot successfully maintain a profit through these loans, then they aren’t going to do this much longer,” says Shashank Rao, the Jim W. Thompson associate professor in supply chain management at the Harbert College of Business. “For the recipient, if this is their only source of funding, then that source is going to dry out. Guess then what will happen to entrepreneurship at the bottom of the pyramid?”

Bad things.

In his co-authored article, “On Operations and Marketing in Microfinance-Backed Enterprises: Structural Embeddedness and Enterprise Viability,” Rao explores why some businesses in impoverished nations are able to repay their microfinance borrowings and others are not. His premise is that voluntary non-repayment is still very low in microfinance, making non-payment an issue of inability, rather than unwillingness, to repay. That leads to the question of why some microfinance-backed ventures fail (and so fail to repay) and how they can avoid the failure trap.

“There is a lot of work out there that says in very small entrepreneurial firms, there are two key investment priorities: one is operations and the other is marketing,” Rao says. “We demonstrated that borrowers who are more embedded in their communities with larger social networks typically tend to invest the proceeds of microfinance loans into marketing—better signage, printing posters and flyers, etc. People less embedded in the community invest the proceeds of microfinance into operations—more inventory, better scales, etc. In an ideal world, both are good if you have enough money.”

If you don’t have enough money for both, should you pay for marketing or operations?

Rao says operations. “Marketing is valuable when there are multiple sellers competing for your business,” Rao says. “But these are underserved communities. They are starving for products. Most established businesses do not yet find it financially viable to distribute goods to them, which means that there is a major shortage of products, sellers, and distribution channels to cater to this segment of the population.

“When that happens, there is limited value that marketing can add—as it stands, marketing, advertising, etc., are concepts that emerge after there is some sort of competition in the market. At the bottom of the pyramid, marketing does not seem to have an influential impact on a return of investment because of this likely shortage of competition. Operations, on the other hand, does.”

The microfinance vendor, in order to be successful moving forward, can’t just be a lender, Rao notes. His work suggests that microfinance lenders must also become business consultants and advise borrowers to invest in operations, thus improving revenue streams and repayment opportunities.

“Offering these findings is a small something that can help people and businesses make better decisions towards a sustainable future,” Rao says. “We’re doing something that has the potential of impacting and meaningfully changing the quality of people’s lives.”