Determining critical success factors in fintech
Zhibek Valevka, Associate at Odgers Connect, talks to independent consultant and fintech thought leader Michael Pearson, about the critical success factors for fintech start-ups.
The past few years has seen a huge increase in the investment going into fintech start-ups and some – such as Monzo and Revolut – have achieved significant scale. One of our independent consultants, Michael Pearson, has conducted research which has been published recently in association with KPMG and Google Cloud on the financing and performance of fintech start-ups in the UK; he believes that it is still too early to tell how the fintech revolution is going to play out.
The research shows that relatively few fintech start-ups are profitable, and many of the companies which have been operating for several years are still losing money. Even so, investors are often happy to continue to back these companies because of the progress they are making on other metrics, and because of the size of the financial services market and the long-term potential for technology-led disruption in the industry.
Michael’s research has also been looking at what defines success for a fintech business. “For investors, a profitable exit is the only real measure of long-term success. The vast majority of fintech investment has been since 2010 and particularly since 2015, so it is perhaps too early to expect many exits,” Michael told me. “A couple of high-profile exits in the UK have been the IPO of Funding Circle in September 2018 and the acquisition of World First by Ant Financial which was announced in February 2019.”
However, Michael explained that success generally comes in stages, starting from raising a first round of funding through to a trade sale or IPO. Stages on the road include building a customer base and then reaching break-even. As Michael told me, in the UK market, 3 of the companies which have reached break-even illustrate some of the critical success factors:
- TransferWise: TransferWise is an international payments company which enables cross-border transfers at very low cost. The company was set up in 2011 and was breaking even by 2017, its 6th year of operation, with £66 million of revenues. As of July 2019, the company had 5 million customers.
- OakNorth: OakNorth is a UK-based SME lending business. The company was set up in 2015 and has a banking license, taking deposits which it lends on to SMEs. OakNorth generated £28 million of revenues in its 3rd year of operation and was profitable. The company claims to have had no defaults on any of its loans due to the capability of its machine learning based credit scoring systems.
- ClearScore: ClearScore is a UK-based company which provides free credit scores and reports to individuals. Like OakNorth it was set up in 2015 and it was generating £28 million of revenues in its 3rd year of operation and breaking even. As of the end of 2018, the company had 7 million users of its service.
“These cases have a few important characteristics which indicate some of the critical success factors,” Michael said. In practice, he argues, several factors combined with the skill and experience of management, and probably some luck, will be the ultimate determinant of success.
“TransferWise chose to enter a market segment where the fees charged by banks and other companies were relatively high. With a low-cost operating model, they were able to build scale before the established players responded. OakNorth focused on the mid-size commercial lending market which the raft of new alternative lenders were not targeting so competition has been more limited,” Michael explained.
There have been a number of marketplace lenders targeting SMEs but most have struggled to reach profitability as the margins for the platform owners are relatively small. Building scale has been difficult as there is no viral effect to rely on. Michael told me that in contrast, OakNorth takes deposits as a bank and lends money from its own balance sheet. This is a more costly operating model in some ways (and potentially riskier) but comes with higher margins.
Proposition, customer acquisition and cross-selling
ClearScore has gained over 7 million customers with a very simple business proposition which is well suited to digital marketing and easy for consumers to sign up to. This is then backed by clever use of data to cross-sell products and services to customers. Commenting on this approach, Michael said, “Of course, the cross-selling of profitable products and services is the Holy Grail which many of the consumer fintechs are targeting having built large customer bases, but in reality, it is not very easy to get right.”
An important aspect of Michael’s research is that he has not found any consistent pattern in the characteristics of successful management teams, even though we know that investors focus on this when considering making an investment. In some of the more successful cases that have emerged so far, the founders have had relatively little experience of financial services or of the specific sector they are targeting, and this is perhaps a surprise. There is also a wide range of ages and experience levels across founders. “Clearly, finding the right formula for the management team is not straight-forward and still takes a lot of judgement,” Michael said.