Managing Payment Flexibility in Rent-to-Own Contracts for Off-Grid Energy Products

Abstract

Problem definition: The diffusion of technological innovations in developing economies has been facilitated by the use of Rent-To-Own (RTO) business models, which give flexibility to consumers by allowing them to make incremental payments over time. Understanding how to best manage this flexibility is a fundamental problem for firms operating in these markets. Motivated by an application of RTO to the distribution of solar lamps in developing countries, we examine the drivers and impact of payment flexibility on repayment performance and consumer behavior in RTO contracts.

Methodology/results: We formulate a stochastic dynamic programming model that characterizes an important dimension of payment flexibility, i.e., the ability of consumers to make
\textit{bundled payments} (multiple installments paid at once, in advance). We show that consumers may bundle payments because of uncertainty about budget in future periods, which leads to a non-monotonic impact of income uncertainty on repayment performance. We further show that bundled payments are more likely to occur closer to the end of the ownership cycle. We examine different flexibility levers that the firm can adjust as part of its contract design (repayment frequency/installment amount, grace period), accounting for the impact of bundled payments. Our results show that an intermediate level of flexibility could benefit both the firm and consumers under some conditions.

Managerial implications: Whereas payment flexibility is a fundamental component of RTO contracts in the developing world, our findings indicate that \textit{a moderate level of flexibility can go a long way} in helping firms and consumers in these environments. Hence, RTO firms may not need to offer extreme degrees of flexibility in order to achieve desirable outcomes. This is an important insight for RTO firms attempting to strike a balance between a sufficient level of flexibility to offer to consumers and good repayment performance.

Keywords: rent-to-own, contracting, payment flexibility, off-grid energy, developing economies