Michael Gilroy
At the end of 2015, Canaan hosted its first FinTech Central event, which included a panel that had leaders from across the marketplace lending originator ecosystem. A marketplace lending originator is a company that sells loans online using retail, institutional and bank capital.
Over the last few years, marketplace lenders (MPLs) have created massive businesses by providing capital to consumers and small businesses more efficiently than banks can. During the panel I posed the question: “What is going to happen to all of the originators? M&A? Shakeout?”
The reason I asked this question, and why so many others in the space are starting to today, is because there are now more than 500 originators active in the market. I didn’t get a clear answer at the time, but the first week of January provided some clarity. The answer came in the form of two almost simultaneous announcements; one from Gilt Groupe, and the other from One Kings Lane.
On the surface, e-commerce and marketplace lending are two incredibly different types of businesses. One has disrupted stores like Macy’s and Sears by selling anything from underwear to couches in a regulation-lite environment. The other disrupted massive banking institutions such as Wells Fargo and Bank of America by selling highly regulated loans.
However, when you peel back the layers, MPLs and e-commerce platforms provide a relatively fungible product, where differentiation comes down to customer experience and price, in markets that breed increasingly low barriers to entry. While there are certainly a number of differences between these two types of businesses, the following similarities paint a grim picture for the vast majority of MPLs.
Pricing is the core product, and provides differentiation — initially
The initial winners in each of these spaces rely heavily upon the ability to dynamically and accurately price supply in real time. At first, these features alone are novel enough to create new and valuable enterprises. Very quickly though, this secret sauce becomes commoditized, eliminating the initial barrier to entry and much of the enterprise value.
The code phrase for commoditization in any market is “as-a-service.” In marketplace lending, we now have very mature lending-as-a-service platforms, such as LendKey, Insikt, Cloud Lending and Mirador. In e-commerce there are literally hundreds of e-commerce-as-a-service solutions, with the primary ones being Shopify, Bigcommerce and Magento. Companies like Lendkey and Shopify allow almost anyone to stand up a lending or e-commerce business over the course of a weekend by handling things like pricing and delivery. Once the pricing no longer differentiates you, you’re forced to turn to scale.
Platform aggregates products from non-exclusive suppliers
Marketplace lending and e-commerce platforms both aggregate supply, lending capital and merchandise respectively, providing a new storefront with a better user experience. Institutional investors and banks in MPL are analogues to the product manufacturers in e-commerce. When pricing is no longer a moat, scale and aggregation amounts become the fallback differentiator — more merchandise variety or loan types.
This does end up being a very real moat, but one that can only be enjoyed by one or two of the top companies in the space. Due to low barriers to entry, and numerous suppliers that are willing to use platforms as a distribution channel, a significant number of companies can gain small to medium scale. In the long run, the unavoidable outcome is that network effects and the consequential pricing power of the one or two winners puts constant pressure on everyone else.
Relatively low repeat purchase business
Lending and e-commerce (depending on vertical) are relatively low repeat transaction businesses. These are high-intent purchases where on the second transaction the consumer is more often than not reacquired online through a marketing campaign or discount. This is a consequence of low repeats, in addition to the increasing variety of choices and platforms.
The result of this combination is a constant battle to stay top of mind and always offer competitive pricing. It is for this very reason that when we conduct diligence on originators for an investment, our very first criteria is that the lender must be profitable on its first transaction (revenue less all variable costs and acquisition).
Low barriers to entry for the business, along with naturally low repeat rates, creates a destructive formula for rapidly increasing acquisition costs as channels get stuffed (Google and Lending Tree stock charts illustrate this nicely). It’s clear when we’ve entered this territory because the CMO becomes the highest paid employee on the team and acquisition strategies turn to things like flash sales and physical mailers to drive meaningful, but unsustainable, volume. Significant organic traffic, enjoyed singularly by those with scale, is the only way that a business can survive here.
Gilt Groupe, One Kings Lane and a handful of others were sold for a fraction of the value that they once traded at because their infrastructure was commoditized and they failed to reach requisite scale to grow profitably. When the infrastructure is commoditized, supplier relationships aren’t exclusive and meaningful customer loyalty doesn’t exist; businesses need to continuously reinvent themselves or face a race to the bottom.
Points one and two are not solvable, they’re constants in the market that have been proven time and time again. As has been the case in e-commerce, the winners in the marketplace lending originator landscape will solve for point number three by bolting on a large number of products, using their scale to price others out and solving for increased repeats at the same time.
The question then remains for MPLs: Who will be forced out of the market, and who will obtain success by evolving from selling books to cloud computing services and logistics.
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