My last post has caused some controversy, and an especially vehement reply from Chris Skinner. I suggest you read his post, actually, before you read this one.
Now, the basic premise of my argument was this: Zopa has the potential to be a disruptive player, but isn't because it is behaving exactly like a bank. It is going after exactly the same customers as banks, using the same means of working out whether they are credit worthy or not, and then pricing loans in pretty much the same way a bank would do. Actually, Zopa loans are often more expensive than bank loans, because they have to make deposits attractive to people with money to lend compared to more traditional investment options.
Let me start by clarifying what I mean when I use that charged word "disruption". It is a word that has become much overused and much misunderstood, in my view. I use the Claytonesque definition which is this (thanks to Wikipedia):
disruptive innovation is a term used in business and technology literature to describe innovations that improves a product or service in ways that the market does not expect, typically by being lower priced or designed for a different set of consumers.
Disruptive innovations can be broadly classified into low-end and new-market disruptive innovations. A new-market disruptive innovation is often aimed at non-consumption (i.e., consumers who would not have used the products already on the market), whereas a lower-end disruptive innovation is aimed at mainstream customers for whom price is more important than quality.
Using this definition, Zopa is not disruptive on either count. They are targeting existing customers of banks who want a loan, firstly. To be a new market disruption, they would have to go after customers who wouldn't consider a traditional bank product, or who would not ordinarily be able to get one. And their loan pricing is certainly not that different from banks, and, indeed, cannot be so given they have to attract depositors from banking products to fund their loans.
Ergo, not disruptive. Note that I don't say cannot be disruptive. Only that they aren't right now.
Chris' chief argument against this is:
…most of these new businesses are based upon a model of social connection first, with finance second. This, to my mind, is the same as First Direct and PayPal, both of which are sustainable. First Direct was built upon a model of being a bank without branches built for the telephone channel. They were targeting the same customers as traditional banks but using a new channel for reach.
Chris introduces a new term here: sustainable. By which he means, I think, that these are businesses which have a future beyond the immediate short term. Now, I have to be clear, I have never once said that Zopa wasn't sustainable. I do believe it has a future, and in fact, I believe most of the new technologically driven banking things that are happening have a future.
What Zopa has, however, is a very thin line to walk. It can grow its business to a certain point, after which it will become material to the business of banks. Competitive pressure will force banks to respond, and that response will be on price. With the ability to cross-subsidise products, they will be able to compete on price far longer than the Zopa monoline will be able to do.
The penultimate point of my argument was that Zopa must know this, and therefore their strategy, in going head-to-head with banks, must be to grow to a certain size, and then no further. This, I admit is provocative, and I know no one really expects that Zopa has this in their brains. Actually, what I'm saying here is that Zopa's present strategy is focussed on the short term, and fails the more successful they get.
Chris then points out that Zopa passed the £50 million loans milestone, and that 40% of that has been this year alone. He suggests that this implies that Zopa is "taking off", and that the pace of growth is "quite remarkable".
It is amazing to me that everyone thinks this a remarkable performance when the big banks are turning away customers. Wouldn't you expect decent growth when incumbents stop supplying product? Actually, why isn't Zopa's performance hundreds of percent up from last year? Considering the pent up demand for lending, there surely must be some reason why everyone isn't flocking to Zopa. Could it be – wait for it – that the Zopa deal isn't all that different from a bank deal? If you can't get a loan from a bank, you can't get one from Zopa either.
Anyway, Chris then goes on to introduce another innovation-technical term: critical mass. That's the time, by the way, that a new idea becomes well enough adopted that you don't have to do anything to sustain further adoption. Usually, the evidence is that you get a period of exponential growth in usage, which quickly peaks somewhere short of 100% penetration over a period of years. Because the rate of change continues to accelerate, the number of years until critical mass occurs has tended to reduce.
As an average across categories, critical mass usually occurs when somewhere between 2.5% and 16% of a particular target market have adopted an innovation. Now lets examine again how ludicrous Chris's statements about critical mass are in the light of what Zopa would need to do in order to achieve it, thereby having a chance of damaging the banks in a way that could not be countered simply by competing on price.
Using Bank of England data, I compute that consumer credit excluding credit cards from May 2008 – May 2009 was about £2.5 Billion. Let's take the easiest case for critical mass first, where Zopa achieves just 2.5% of that, or in other words, writes £62.5 million pounds of loans in the last year. Their actual achievement is 80% of that in their whole lifetime. Some time to go before "critical mass" is reached, I think. But Chris hypothesises that Zopa could achieve that in two years, by 2011. The fact is, they haven't, even when being in the centre of a perfect storm for the incumbents making their business the most viable it could ever hope to be.
Now finally, let me finish off this post by clarifying one last thing. No group of banks is going to band together to "kill off" Zopa. But competitively, they will respond, and they'll make the battleground price if they start to lose significant share. This will be an automatic reaction and part of business as usual. Zopa cannot compete on price, because it is a monoline, firstly, and doesn't control the price of the capital it lends to the same degree that a bank does secondly. Therefore, if Zopa is forced into a price war on rates, it will lose.
Chris argues that it can win a price war because it has "razor thin margins". That's a stupid argument because it assumes that Zopa makes money through interest income, which it doesn't. It is a fee based business. Consumers care about fees, but firstly they buy on the basis of the interest rate. Zopa has control of fees, whereas banks have control of fees and the interest rates they charge.
Chris makes a few final parting shots at me by suggesting I am a luddite banker, and uses my previous suggestion that "twitter is a stunt for banks", whilst pointing out that I have adopted it personally as evidence that I have to be shown the wood for the trees before I'll support anything. I haven't changed my position on Twitter, by the way.
But I do have this to say, Chris. For someone who is retained regularly as an expert commentator on our industry your failure to see beyond banking-techno-gadgetry to reality is surprising to me. In fact, as you say, it is evidence that "Zopa Zealots and Smartypig Saints caught up in the church of the Internet" are alive and well.
Update: Chris corrects my maths, and I've changed my post to correct the error. But the change in the numbers doesn't have any effect on the argument, in my view.
Thanks for the response James, which is well reasoned.
But 2.5% of £2.5 billion is £62.5 million ... and if Zopa wrote £20 million in the last year, then it is reasonable to assume critical mass by 2011.
Equally, I widened the debate to all social finance and recognise, now that you've illuminated further, that you purely are throwing rocks at Zopa.
Zopa's biggest challenge is to get funders for loans to join the site. Thanks to the credit crisis and lack of savings interest rates, they are getting this, as you say.
But I am not a Zopa spokesperson or representative, which is why I widened this to SmartyPig, Prosper and more.
Finally, let's not get into more of a bun fight and my comments about 'luddite' was at your banking represented view generally rather than you as an individual.
My comment about teeth puller and multigeneration criminal are more due to that fact that you should bear in mind that there is a cricket match taking place at present between England and Australia.
This makes you a natural target :)
Chris
Posted by: Chris Skinner | August 19, 2009 at 09:38 AM
Just checked my stats
Total consumer credit lending to individuals at the end of June 2009 was £231bn. The annual growth rate of consumer credit continued to fall, to 1.9%
However, this does not take into account net new consumer lending. Do you have that figure?
Posted by: Chris Skinner | August 19, 2009 at 09:41 AM
Touche!
The Internet graveyard is scattered with companies that were praised as being disruptive, only to be found out to be the using the same staid business model masked by the Internet.
Posted by: Andrew | August 19, 2009 at 09:43 AM
Sorry - will try not to keep adding (James - feel free to combine these comments) but the figure I found was that consumer credit lending grew by £0.1bn in June 2008 compared with total lending in January 2008, when it grew by £8.4bn.
If this is true, then bank lending is going to be about £1.2 billion this year. 2.5% of £1.2 billion would be £30 million ...
Posted by: Chris Skinner | August 19, 2009 at 09:43 AM
I used the BofE stats for consumer lending May last year to May this year. These are the actual numbers, and include some where lending actually was negative. The figure I got, excluding Credit Cards was 2.5 billion. The date is on their site (but am not on PC at the moment to send link).
Thanks for correcting my maths, though the changes don't affect the argument :-)
Posted by: James Gardner | August 19, 2009 at 09:48 AM
You are taking total consumer lending.
Net new credit lending to consumers grew by £100 million in June 2009.
http://www.creditaction.org.uk/debt-statistics.html
Net new consumer lending is therefore running at £1.2 billion this year. 2.5% of £1.2 billion would be £30 million and Zopa grew by £20 million in the last year.
Therefore, Zopa could easily expect to gain more than 2.5% of net new lending this year unless bank lending picks up.
I think that does affect the argument?
Posted by: Chris Skinner | August 19, 2009 at 10:04 AM
Not really. I am just using different estimates to you. Mine come from the lending panel run by the Bank of England.
But let us argue 1.2 billion for a moment. 2.5% (that's the minimum, don't forget) means a bigger growth in lending than they've ever achieved ever, AND they have the benfit of contraction of bank lending. That's not going to be the case for all that much longer.
But also consider this: we don't know that critical mass will be 2.5%. It could be 16%, for all we know. In fact, it almost certainly *won't* be 2.5%: that's just the low order average.
So no, none of this changes the argument, in my mind.
Posted by: James Gardner | August 19, 2009 at 10:37 AM
As I say, Zopa can argue their own corner. I am purely (a) stating facts as you place them which, with your updated Bank of England figure of £62.5 million means that Zopa currently gain 1% of total lending; and (b) would rather not defend Zopa explicitly, but am defendng the model of new business they and their siblings represent. If Zopa never achieve anything long-term, I am not the one who is fighting their corner and being their champion. I purely like the new social finance focused modle they bring to the market, as do SmartyPig, Prosper, Mint et al.
Posted by: Chris Skinner | August 19, 2009 at 10:44 AM
James, to qualify an innovation as disruptive, it is more the change in business models (and corporate culture) that is associated with commercialization of the innovation that should server as a reference. In fact Christensen says that addressing a market of non-consumers is a natural path to make a disruptive innovation prevail, but this is not a prerequisite.
As a young startup, you must first decide if you will act as an enabler for traditional firms, or as a competitor.
An enabler will provide innovations that will help traditional firms doing a better (and more profitable) job.
Competitors will either be contenders (trying to grab portions of the market - at the lower or highers ends - doing exactly the same job than what the traditional firms are doing) or disruptors (doing a fundamentally different job).
The catch is that it's often very difficult to know ex ante if an innovation is truly disruptive, or is just a new variation of the same business model (think of online banking and how difficult it was then to know that it was "not" disruptive). A test is to try spotting if traditional firms do understand the innovation but do not identify the incentive of doing it, or actually do not understand the innovation or, if they do, that their arguments sound very much as coming from denial syndrome.
Jury is still out to know if social lending will be successful and if it is truly disruptive. But it seems to me that we hear a lot of denial statements coming from traditional banks.
Posted by: FredericBaud | August 19, 2009 at 10:51 AM
By the way, just to be really picky, I didn't say that Zopa's pace of growth "quite remarkable".
Like you I was quoting from Martin's original post about Why Zopa Matters from the Zopa blog. So you should have put that in context rather than making it look like I said that.
Posted by: Chris Skinner | August 19, 2009 at 12:35 PM
(Posted here as well as your original post)
Hi James, Martin here.
Given the blue touch paper that you have clearly lit here, I find I can barely keep up with all the different shots that are being fired back and forward – fun reading though!
As the chap who started this game off with my original post on the Zopa blog, can I just interject to address a key mistake being made in some of the assertions…
I disagree with you (and possibly others) that one or more banks “could kill off Zopa with a price war because Zopa’s pockets aren’t deep enough”. WRONG! The depth of Zopa’s pockets are virtually irrelevant because Zopa is not a lender, it is a MARKETPLACE.
Zopa does NOT set the rates. Lenders choose their own rates, and if borrowers think they are good enough they will take them up. If they don’t, they won’t. Prices are NOT a function of the depth of Zopa’s pockets.
If banks wanted to destroy Zopa through a price war, they would have to undercut all the people lending on Zopa by offering rates MUCH lower than they are now. Or they would need to offer would-be lenders on Zopa hugely better rates on cash savings to remove the attraction of lending on Zopa.
Ironically, it’s the banks that cannot afford this price war:
Firstly, the price advantage for both borrowers and lenders at Zopa is very large, especially at the moment while banks are charging such huge spreads across loan and savings products to try to rebuild their shattered balance sheets.
Secondly, bank overheads are enormous and hard to shrink. In stark contrast, Zopa’s operating costs are wafer thin, and because of the way the model works, will only get proportionately smaller as the business continues to grow in size.
Thirdly, and perhaps the real ‘show-stopper’ for any bank trying to kill off Zopa with a price war is the bank’s inability to target the loss-making offers. There is no way to target Zopa members directly or even indirectly, so these undercutting price offers would have to be made to the entire country. That in itself would destroy the bank concerned long before it would shut down Zopa.
Finally, I think you need to think about what you are proposing banks could or even should kill off. It is real people trying to get a better deal by bypassing the banks and dealing with other real people instead. Given banks’ current popularity, most people would view cynical strategies like you suggest as a disgrace (and potentially illegal), especially if the banks concerned were majority-owned by the taxpayer.
Over to you guys...
MC
Posted by: Martin Campbell | August 19, 2009 at 06:42 PM
You say that something can only be disruptive if the newcomer targets the a different audience than the established players? How does that work? It seems like a contradiction.
Why would anything be considered "disruptive" if it isn't going after the same consumer segment. Where's the "disruption" to established players if their business model is unaffected when a newcomer offers new services to customers the established players don't have?
If you're selling stuff I don't offer to customers I don't have, why would I care? It's not disrupting me at in the slightest. It may qualify as "innovative," but "disruptive?" I don't think so.
Posted by: Jeffry Pilcher | August 19, 2009 at 09:52 PM
Bottom Line: You aren't disrupting me unless you're stealing my customers.
Posted by: Jeffry Pilcher | August 19, 2009 at 09:53 PM
Incredible discussion. There is one thing that sticks out for me though, and Jeffry just nailed it in prior comment.
Disruption and James definition using carefully selected words from wikipedia are at (James words) the core of the argument, and therein lies the fatal flaw, whereby the rest just falls away.
Disruption in the wikipedia I am looking at says"Disruptive technologies are particularly threatening to the leaders of an existing market, because they are competition coming from an unexpected direction"
The other flaw here lies in the fungibility of money. Banking is not that complex, and neither is money. One could argue that disruption in banking will only occur when Dave Birch re-invents transactions and we don't need pounds or dollars in cash anymore.
However I think it remains reasonable that disruption in banking is not reserved for the money part, but also applies to the methodologies that support delivery of the money. This goes to the core of the productivity gap.
I say let the Banks continue using branches, and let Zopa continue to automate the parts that can be, while they streamline the rest. Banks cannot do that for a few reasons imho:
1. banks brand model is too risk averse and won't allow it
2. banks cannot respond to disintermediation, because they would be disintermediating themselves - a problem not lost in the argument above
3. banks' internal technology information model is not scaleable - it needs people to operate it, which becomes a recursive and circular trap for them.
Posted by: Colin Henderson | August 20, 2009 at 06:19 AM
I don't know if the potential disruptive chatacter can be nailed down to the branch aspect, but I believe that the fact that decisions are decentralized in the p2p lending's case (it is a marketplace) and centralized through capital allocation, limits,.. in the bank's case can indeed create a situation where banks will find it difficult to incorporate the new model (if it proves successful) in their standards of operations.
Posted by: FredericBaud | August 20, 2009 at 07:28 AM
I'm also noting that the disruptive influence, having heard Christensen present this a few times, is focused upon how new entrants gain market share.
Christensen states that the issue incumbents have is that they are so wrapped up in their existing customers that they keep thinking they have to add function to the product, making it more complex and costly.
New entrants succeed by targeting existing markets with no-frills versions of an incumbents product at a tenth of the price.
That's exactly what Zopa is doing.
Posted by: Chris Skinner | August 20, 2009 at 08:16 AM
Chris.
Zopa is not providing its services at a 10th the price. In fact, its loans are quite often very much more expensive than those offered by banks. This, of course, is my whole point.
Posted by: James gardner | August 20, 2009 at 09:53 AM
A contribution to the debate, although I'm not sure what any of it means. There was a discussion about Zopa going on in my office this morning, a couple of the guys have money in Zopa earning about 8% at the moment...
1. Always lend money at the weekends because the interest rates go down in Monday. Zopa work office hours, so when they come in Monday morning and clear out all of the deadbeats then the money in the pot goes up so the interest rate goes down.
2. When banks make stupid loans that go bad, they get to write off the bad debt against capital gains tax. If a Zopa investor makes a stupid loan that goes bad, they can't. So isn't there an inherent financial advantage to being a bank?
3. Many people don't invest in Zopa because of a commitment to optimum financial management, but because it's interesting, and a sort of fun. Knowing where your tenner tranches have gone makes investing a sort of entertainment. This may be the distruptive aspect, because it changes the value network.
Cheers,
Dave.
Posted by: Dave Birch | August 20, 2009 at 10:34 AM
James
The rates are set by funders who are individuals based upon their risk appetite.
The rate you borrow at is based upon your risk profile, as you say, using Experian et al.
The more risk a funder wants to take, the higher return on their funds and the more paid by a borrower to access those funds.
The less risky a borrower's profile, the less interest they pay.
The only correction I'll make to my point is that Zopa run this at a tenth of the cost, as they don't set the price as Martin explained.
Are you not taking any notice of his response?
Chris
Chris
Posted by: Chris Skinner | August 20, 2009 at 10:53 AM
Chris, you assert that if you take more risk you get a higher return. At Zopa you really get a lower return for taking more risk.
Easy lend sets rates to be the same after Zopa's fee and estimated bad debt, ignoring tax treatment of bad debt. Only those who are not tax payers get even the same expected return for taking more risk, everyone else gets reduced returns as risk increases because of the tax treatment of bad debt.
The bad debt provisions also mean that in practice higher rates after fee and bad debt allowance are achievable in the lower risk markets than in the higher risk C market even if you ignore easy lend. Using the 27 August 2009 market data spreadsheet the highest matched rates were:
Before fee and bad debt allowance
A60: 19.9, 18.9, 15.4.
C60: 20.0, 19.9, 19.5
After fee and bad debt allowance:
A60: 18.1, 17.9, 14.6
C60: 14.8, 14.7, 14.3
So, better rates for A than C, even before dealing with tax on bad debt.
That C rate is bogus. The applications giving the top ten rates in the C60 market were rejected and the highest rate really achieved in C60 was around 17.7% before fee and bad debt allowance, 12.5% after fee and bad debt allowance.
That's a 2% premium for lending to the lower risk market. Your theory is a nice one and I wish it was right but reality disproves it.
14.6% is still quite a juicy rate and who can be unhappy about it, except the lucky A class borrower who's paying someone that rate? I wonder what 0% balance transfer deals Lloyds is offering on their credit cards this month... 3% fee for 12 months at 0%. But Virgin will do 16 months for 2.8% fee. I wonder if an A market borrower can qualify for that and get 16 months for a hair over 2% APR? That seems to be undercutting Zopa lenders quite thoroughly even if there might be a few months at 16.6% on the low balance at the end of the term... if the balance can't be transferred. Virgin will do a balance transfer to a current account, it's not limited to other cards.
That's OK, Zopa offers quotation searches. Good move. Now go look at Barclaycard doing the same and wonder what happens when that becomes more widespread and it's easy to see whether you'll get the 0% deals before you get a full search on your credit record.
Posted by: borrower | August 31, 2009 at 12:11 PM