February 14, 2018
Lost in the headline-grabbing news events of January 2018 (including Davos, the Budget, India-South Africa cricket series, and the stock market) was another RBI update on bank credit. While certainly not as interesting as the other topics it had a notable piece of information: consumer lending rose 17.3% in November and at the fastest pace since September 2016. This is probably the first strong evidence of the diminishing impact of demonetization and an increase in credit activity.
For financial institutions and a slew of providers ranging from FinTech startups to new-age NBFCs, this is great news to kick off 2018. In our last post on this topic, we highlighted the massive consumer lending opportunity but also the inverted credit consumption pyramid today. The top 24 million households have deep access to credit and consume in excess of 70% of formal loan disbursements in India (estimated at $287 billion in 2017). But if you fast-forward ten years, the situation could look very different.
India’s consumer credit market is projected to grow 4.3 times to $1.3 trillion by 2025. The bulk of consumer credit growth over the next decade is not from the top two segments. The middle of the pyramid – Aspirers and the Next Billion together are likely to account for ~50% of total credit usage – growing 7 times from $85 billion in 2017 to a staggering $590 billion in 2025. You can read the complete post here.
This is a shift driven by:
1. Increasing prosperity leading to an upward shift in incomes and access to the formal financial services ecosystem; and
2. New product and distribution platforms that can leverage smartphone penetration and open APIs such as the India stack, as well as policy tailwinds in order to offer solutions that gain widespread acceptance among these new segments.
Over the past two years, we have met dozens of consumer lending startups and new providers but most of them were focused on the Elite and Affluent segments. While it’s not a market to sniff at, it’s a small pond compared to the vast blue ocean that represents the middle segments.
The good news is that there are a growing number of smart entrepreneurs and forward-looking companies who have caught on to the potential of the large middle and the changing shape of the credit consumption pyramid over the next 7-10 years.
Based on our work, we have a few observations on the success criteria needed to build a sustainable and profitable business for this segment.
The one-size-fits-all approach does not work when it comes to financial services in a place like India. The reason this segment has high barriers to entry for traditional players (even if they can solve the cost of onboarding with the India stack) is that the current products from the top of the pyramid do not fit the needs of these consumers.
A consumer making between Rs. 5–15 lakhs a year in family income is different in terms of their priorities, needs, and ability to pay. To crack the 600-billion-dollar emerging credit opportunity, new entrants have to rethink products from the ground up. These products have to be designed for the middle segment while solving use cases that often have no relevant consumers at the top of the pyramid.
The first problem we see most successful teams solve is identifying real, value-added use cases in reasonably large segments. Unlike at the top of the pyramid, these use cases are not homogenous across income segments and need some fresh solution design.
For example, unplanned health emergencies are the single largest cost for many middle and lower-middle-income families. A few startups have zeroed in on this area and on rolling out innovative health-focused planning and investing products. A few of these products don’t have any applicability to the first two income segments.
Managing the seasonality of credit needs is another example. Coming up with Rs. 50,000 for a child to attend a good school is a major credit need in the summer months. We are seeing interesting education loan startups that are focused on making middle and high school tuition loans available at affordable rates. Innovation is often around business models. In the case of the student loan, credit is routed through the school and repayments are linked to school access.
In the next segment of a billion, home repairs are a frequently cited source of need. These are structural improvements and not discretionary home improvement projects. This extends to credit for weddings and pilgrimage travel. While listening to entrepreneurs and consumers in this segment, it also became clear that consumer credit at this level is more likely a bundled solution. Without a credit history, it’s very common to have loan applicants first prove their saving habits for a few months and build capital before they are provided a loan. The consumer avails credit from formal and informal sources without specific disclosure of planned usage of funds. For example, something broadly identified as a consumer loan could be used to support a small business run from the household. Families tend to have multiple accounts for family members within a given bank. These are all examples of dramatically different use cases that need to be cracked by those seeking to own the large white space.
The first generation of FinTech solutions focused more on mobile-centric technology products and less on distribution. It’s safe to say that a 100% mobile-only strategy has had poor results. Even Paytm has invested millions of dollars in physical outreach to small businesses to get their accounts running.
What is interesting is the evolution of thinking or the lessons learnt for targeting the middle of the pyramid. Startups still want to own the digital interface to the consumer. However, the rational go-to-market strategy is increasingly a hybrid mobile and pragmatic online/offline distribution approach. Many of these consumers are just purchasing their first smartphones and do not have the ability to manage a full loan process on their mobile device. Rather than wait for consumers to adopt smartphones and hope for the best, many providers are digitizing the supply chain for new products and arming agents or business correspondents with the technology platform. As the end consumers observe agents using the application, it creates familiarity. The goal is to own digital loan issuance and management and cover as much of the last mile as feasible at this point in time. This go-to-market approach is again a significant point of departure from what is being attempted in the first two customer tiers.
We have found this to be effective where startups have provided this capability to partner banks as a way to leverage new digital processes without having to reinvent the entire digital solution in-house. This is usually much more effective outside the very largest banks who seek to build their own platforms for each product.
The biggest barrier to entry a new entrant can erect in the white space is around consumer and transaction data. This is still an unmapped territory with millions of new-to-credit and thin-file consumers. Formal credit footprints of any kind have stayed in numerous passbooks, physical loan applications or with business correspondents. By digitizing even portions of this process, startup first-movers gain a significant advantage and the ability to get a jump on larger players who may move in later.
The lending use cases (wedding, education, medical emergencies, etc.) for the middle of the pyramid are largely personal loans, formal or informal. In all of these cases, a financial institution or a money lender underwrites the individual by assessing their capability to pay based on traditional and archaic underwriting resources. This is changing fast.
It’s pretty amazing to see how rapidly the combination of Aadhaar-driven eKYC, digital transactions via UPI, wallets or BHIM is creating a torrent of previously unavailable consumer and transaction data to use for underwriting. More than any other country in the world, the India stack (Aadhaar, eKYC, UPI, and digilocker) is enabling digital infrastructure at an almost unimaginable scale.
The challenge for new providers is to innovate with data insights on top of this stack and not just use its base capabilities to mimic an existing product. Too often, we see new entrants believe that their differentiation is simply in using the digital stack – improving turnaround times while having a lower cost of service delivery. This is unlikely to lead to large and innovative new businesses. In our view, the answer lies in identifying and solving for difficult use cases that traditional providers struggle with. The India stack becomes the engine but you have to build a new car and head towards the unmapped roads of the opportunity at the middle of the pyramid. They can accelerate using data insights that enable unique solution offerings as well as new monetization opportunities unavailable to traditional products.
The large banks have the classic challenge of finding the strategy, execution, and willingness to move down the market to lower-margin products. A few public sector banks or private banks we have talked to seem to don’t have any real strategy for the middle of the pyramid. They are pretty focused and doing a reasonably good job at leveraging new technology stacks to cut costs and improve mobile consumer experience at the top of the pyramid. This is their profitable customer base and it needs to be protected.
In our view, NBFCs are better positioned than banks to make a move on the lower portion of the Affluent and Aspirer segments. They have a better understanding of the Aspirer segment and often specialize in areas that matter, such as housing, two-wheelers, and education. Among NBFCs, there are several new-age technology-centric ones with specific segment focus that are likely to catch the wave faster than others.
The larger consumer platforms such as Amazon, Flipkart, and Paytm all have an eye on this lending opportunity. The advantage for these players is their reach, brand, and customer base. A payment platform such as Paytm has an edge but all players need to overcome the challenge of solving for drastically different use cases in the white space segments. We are likely to see them get there by acquiring strong products that can gain traction in new segments. The dark horse among larger platforms is clearly WhatsApp. No one has more reach and greater consumer usage in India, and their recent entry into payments is likely to be a precursor to a foray into associated financial products.
Despite these large players, we feel the greatest opportunities (albeit with higher risk) are for FinTech startups targeting the middle of the pyramid. Unlike in the Elite and Affluent segments, startups will not fight for market share with incumbents. They are more likely to take a first-principles approach and design products for this segment. These are also areas that larger players may pass up initially as they seek mega-scale from day one.
For FinTech startups, the big questions are around strategy, choice of segments, use cases, and distribution approaches. Pick too small a segment – no matter how innovative – and it may be hard to monetize in a price-sensitive market like India. The good news is that there are real use cases, large addressable markets, and viable economic models for the truly innovative.
Note: Acknowledging primary research and analysis support during June–September 2017 from Yash Jain that served as inputs to this post.