Digital lending is not a winner-takes-all business

Several entrepreneurs and investors have argued that a digital lending “winner will take all”. The evidence seems flimsy.

First of all let’s clarify that we are talking about unsecured consumer credit here, and not small business loans. Business lending (even completely digital lending) will never be “winner-takes-all” because there are simply too many business verticals that need credit, and no one lender has the insight, relationships and data to grab all of the verticals for itself.

But when it comes to consumer lending (like M-Shwari, Branch, Inventure etc), I’ve heard the “winner will take all” argument several times from entrepreneurs and investors. Apparently, one player who gets in early and figures out a model will scale up dramatically and capture the lion’s share of the market for itself.

Bellwether examples have structural differences

Proponents of this argument probably have in mind companies like Facebook, Amazon and Google. Perhaps even PayTM, the Indian mobile wallet leader, which is reported to have 40% of all mobile wallets.

But key structural differences drove the dominance of these players.

Facebook benefits from the network effects of a social platform. It gets more valuable and harder to defect away, as more and more of my friends join.

Google is used daily, even multiple times a day. Once I’m habituated to using Google, breaking the habit for another search engine will be tough.

Amazon expanded from books to many categories. I might have price-shopped between Amazon and Books-a-Million ten years ago. Now it’s simply where our family shops for almost everything.

Consumer digital credit is different

Online and mobile lending does not have the inherent network effects of a Facebook or the daily habitual use of a Google. And it’s unlikely that an online lender can forge a meaningful social network among its customers. So if those two paths to a winner-take-all endgame are out, what about the Amazon approach?

Sure, like Amazon, a consumer lender could conceivably expand into savings, insurance and other financial products (investments, payments etc), thereby locking in a dominant position. But unlike adding electronics to books, this requires a bank license, embracing an entirely new business model, and a significant departure from the core brand. Lending is about speed and cost. Savings is about trust and accessibility.

INGDirect Australia makes my point (although the model is well known for savings first, not loans first, like I’ve been talking about). Even in Australia, where ING Direct has been since 1999, there are only 3 financial products on the website: savings, superannuation (retirement savings), and a home loan. A few years after attempting to become a mainstream player, it remains niche, albeit with impressive financial results. Bottom line: scaling horizontally across financial products is easier said than done when one is a purely digital player.

Another structural reason: open “stacks”

Another structural reason why consumer digital credit won’t be winner-takes-all: its underlying “stack” is open. The stack I refer to includes two biggies: a) e-wallets or accounts; and b) some form of payment mechanism. These are what allow anyone with an account — regardless of what bank he/she uses — to apply an get an online or mobile loan. Money can move from the lender to the borrower using cheques, fund transfers, etc. regardless of which bank is sending and which bank is receiving the money.

In Kenya, Safaricom owns the stack because that is the dominant electronic wallet/account. Safaricom leveraged its stack ownership to launch MShwari (with Commercial Bank of Africa), and this remains the dominant digital credit product. Still, over time, that stack has opened up (by regulatory force and because Safaricom can grab part of a bigger pie). This is allowing multiple banks and new entrants to compete in mobile lending, and one can foresee a time when Safaricom is not as dominant in this space as today.

Finally, some business school theory

Porter’s five forces says to look at how suppliers, substitutes, consumers, new entrants, and industry players will interact.

As mentioned above, when it comes to an online/mobile loan, consumers want speed and cost above all. So any dominant player in the digital credit business better be cost-competitive, or it won’t be dominant for long. Are there substitutes or new entrants who can compete on price?

Yes — if large banks with a low cost of funds are looking for growth opportunities. Once the market is mature, and many borrowers have an accessible credit score, these are the giants enjoying a low-cost deposit base that might be able to poach the best borrowers from market leaders, by dangling cheap loans. Who knows, these banks may even already own the borrower’s checking account, making it that much less costly to sell the loan.

The flip-side of the question

The flip-side of “is digital credit winner-takes-all” becomes far more interesting as an entrepreneur, and much more relevant to designing and rolling out a new product. The flip-side is simply “how does one build defensibility into a digital credit product?”