More on the long tail

A couple of days ago I spent some time ruminating on what the Long Tail - the business idea that it can be profitable to sell a little to many small markets - might mean in banking. My basic conclusion was that for organisations currently involved in banking, long tail markets might be an opportunity to get more revenue, probably with other people's products.

As I mentioned then, there are a number of problems that need to be overcome to make a long tail banking business a reality, not the least being getting a close to zero cost to serve product. For banking that's a tall order, if what you're going to be doing is selling the products of other banks.

But then I came across Zopa in the UK and, in the US, Prosper, which are quite a different take on banking related long tail businesses. Both sites enable consumers to lend money - at an interest rate and term they choose - to other individuals who want to borrow. Let me concentrate on Prosper for a moment, since it seems to be a little more advanced that it's UK cousin.

The key innovation in Prosper is that borrowers are able to post a request for a loan using terms that suit them. Other individuals - and it could be hundreds of them - then offer to fund part or all of the loan at an interest rate that makes sense to their personal situations. The system matches up the least expensive funders to the borrower and sends out the money in a chunk. A further innovation is the ability of a borrower to join a group, which then takes some collective reputational risk on the loan in exchange for better loan terms. Social networking applied to the process of consumer lending.

What is the benefit for the lender? Funding loans in this way essentially results in a completely custom savings product - a product where the lender determines the rate and term of the deposit. Since the rate is a reflection of the riskiness of the loan, what results is a niche savings product that specifically serves the personal circumstances of an individual.

According to Chris Anderson, one of the driving forces behind the Long Tail is democratization of the tools of production. For lovers of video, it is possible to use cheap tools to make what was once the domain of the studios. Print on demand does the same for books. Ebay makes anyone a retail shop front. In the Long Tail thesis, when you have democratization of production, you get markets with a lot of choice - an explosion of niche products. When you add in zero or low cost distribution and declining information asymmetries, all those niches sell.

What are Prosper and Zopa doing? Democratising the production of loans: now anyone can be a bank! Selling the niche: chances are the loan terms that best suit you are going to be available where there are thousands of consumer created loan products. Zero cost distribution: the loan is matched and fulfilled automatically.

Zopa and Prosper are long tail business.

I wonder how many banks actually know of the existence of these businesses though? Or if they know them, have an inkling of what it might mean for them?

Banks have always had a special (and very profitable) position in society because of their unique relationship with the economy, their ability to manage risk collectively, and most of all, their leverage of information asymmetries to make them the best place to match the needs of investors and borrowers.  For the unsecured personal loan (an admittedly simple banking product) the long tail nature of Zopa and Prosper completely unhinges the value proposition of traditional banking.

It is only a matter of time before clever people find a way to make a long tail business work for a mortgage. And that, frankly, has the potential to do some very nasty things indeed to the results of incumbents in the banking industry.

Comments

[sheel]

Check out Kiva.org, long tail in philanthropy. Pretty interesting stuff.

Here's some detail from businessweek:
http://www.businessweek.com/magazine/content/06_31/b3995088.htm?chan=search

and a video from ABC:
http://abcnews.go.com/Video/playerIndex?id=2239631

[Steve]

Prosper just released performance data, what do you make of it? It's a lot of data - any conclusions?

http://www.prosper.com/public/lend/performance.aspx

[James Gardner]

Hi Steve:

I've broken out the data by month. There are some interesting trends, but there's only meaninful numbers since about January this year.

Having said that, the value of loans in arreas seems to be low as a percentage of total loans written. A result of the social aspect of Prosper perhaps? I could imagine that you'd be more careful about your obligations if memebers of a group are also affected.

I'm also interested in the growth trend in the loan book. Again with only half a year of real data, its impossible to say anything, but there seems to be a spike in the last few months which tails off. A correllation with the write up in the Economist and elswhere perhaps, rather than any indication that we have a complete diffusion curve for the innovation.

I'm going to wait for a bit more data and then post something substantive on this. Kudos goes to Prosper, though, for releasing data of this kind.

Thanks for taking the time to post a commment, Steve.

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[David]

That is a great strategy. Business owners looking to create new buzz for their business can always follow the leader, either by copying their strategy or just simply by being next door!

Great post!

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Obtaining capital in this market is easier said than done. Banks are going belly up, lenders are increasingly making it more difficult to obtain capital. If you have an existing business, the easiest way to increase your operating capital isn’t to go get more loans. Business finance should be your last option because Commercial banks are lending, but are very picky.

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