SMB Lending: Marketplaces vs. Banks
February 14, 2019
During the last 25 years, about 7% to 9% of small businesses close each year on average – slightly less than the number that open – according to LendEDU. Among the reasons small businesses close, access to credit is becoming less of an issue in why a business closes compared to during the Great Recession: only 5% of businesses closed in 2015 because of lack of credit compared to 14% in 2007.
The democratization of financing due to the expansion of the types of players and credit product options has its pros and cons but one thing is clear – anyone can lend today. Why? Data.
While lending to consumers is straightforward enough in terms of access to massive behavioral and transactional data on a number of platforms of different types – e-commerce, internet companies, social media platforms (Facebook alone tracks 98 personal data points for each of its 2.19 billion monthly active users to target ads), etc. – successfully lending to small businesses at scale is a much more complex task. While SMEs represent over 90% of the business population, 60–70% of employment, and 55% of GDP in developed economies, financial institutions have difficulty addressing the needs of this market.
According to Biz2Credit Small Business Lending IndexTM, small-business loan approval rates for big banks were at a record high of 27% in January 2019. With big banks denying the vast majority of small-business loan applications, the role of other lenders becomes increasingly important. For example, small-bank approvals were at 48.9% in January 2019. Institutional lenders were approving 65.1 % of small-business loan applications and institutional lenders were approving 65.1% of the applications in January 2019.
Small businesses overlooked by traditional lenders have created an opportunity for outsiders to fill the niche. In fact, the loan approval rate among alternative lenders was at 57.3% in January 2019, which is a slight jump from December 2018.
But even alternative lenders found their match – the new power players in small-business lending are potentially massive e-commerce platforms. Among the reasons that companies like Amazon are the most natural winners of SMBs is because marketplace-SMB relationships are (almost) a win-win.
The power of any marketplace is in the scale and success of its members. There would be no Amazon marketplace without thousands of companies – big and small – and micro-merchants bringing their business into the world of Amazon. Amazon marketplace contributes $135 billion globally to Amazon’s own sales. By some estimates, the marketplace will have grown to $259 billion by 2020.
If we were to take the smallest members of the marketplace, Amazon is still impressive in its scale – there are 100,000 sellers with $100,000 or more in sales a year on Amazon marketplace. About 19% of Amazon professional merchants are estimated to have brought in more than $1 million in sales in 2018. In 2017, Amazon made $1 billion in small-business loans to more than 20,000 merchants during a twelve-month period in the US, the UK, and Japan.
While a fairly significant portion of merchants sells with other marketplaces too (eBay, own website, Walmart, Shopify, physical stores, Rakuten, AliExpress, etc.), nearly 50% are estimated to be selling almost exclusively with Amazon, with revenue from the massive e-commerce marketplace accounting for 81–100% of their sales.
It’s a natural extension of any merchant acquisition strategy for a marketplace to offer merchant financing. Marketplaces are better positioned to do it at scale as well as more successfully than financial institutions because marketplaces have complete visibility into the merchants’ online operations – sales, dynamic, customer relationships, disputes, cash flow, inventory performance, and its evolution – no financial institution is that deep into operational efficiency and performance when it comes to small-business loans.
Marketplaces have the opportunity to not just provide all the tools for a merchant to run an online business, they get much more in return – the precious data from every aspect of a merchant’s online operations. By pooling merchants’ performance data with consumer behavior analytics, marketplaces can be much more accurate in targeting (hence, successful conversions), risk assessment, and management, and, ultimately, in better loan recovery.
Why is this not the case with financial institutions?
Some professionals fairly note that banks tend to provide personalized services for a few high-value customers or automate services for a mass consumer market – and SMEs don’t fall into either. Their size doesn’t make them any less complicated than any other business but financial institutions are just not as keen to invest effort in understanding the needs and circumstances of small businesses and take an unproportionate risk. Estimates shared by FT suggest that globally, there is at least a 2-trillion-dollar gap between small-business demand for financing and what financial institutions are willing to provide.
There is another side to the mismatch. Some estimate that only 10% of all small businesses have up-to-date and accurate accounting information. This means that 90% of small businesses are unable to produce dependable financial statements when required for an application at an institution.
Marketplaces have full and deep visibility into merchants’ financial performance on their platforms, which eliminates the need for any resource-consuming reporting function for a merchant to demonstrate its trustworthiness. The marketplace already knows whether it’s true or not. Baidu, for example, uses big data, machine learning, and facial recognition technology to help it vet a borrower’s eligibility for its loan. Borrowers make repayment of the loans through its mobile wallet payment application.
If you look at the small-business hierarchy needs, they need access to cash (and) funds; they need time, and they need more sales. And what if you were able to provide an efficient system that gave them more time to do all their work, access to capital, and something that boosts their sales line? You could see how that player could win over a traditional player or even a new FinTech. – Karen Mills, 23rd Administrator of the US Small Business Administration (SBA)
Mills, who served as the 23rd Administrator of the US Small Business Administration (SBA) believes that the tech giants would probably push to disrupt the market and deal a blow to established lenders.
I think they are going to dominate the market, and that is the next phase that’s coming, said Mills. If you think about what Amazon already knows about its merchants, and then you think what Google knows about everybody who is buying and selling through its platform, one can imagine a world where they have much more information about both on the credit side but also on the small business itself.
The online retailer, which in 2017 shipped 5 billion+ packages through its Prime program, is looking for hundreds of entrepreneurs with little to no logistics experience to set up their own delivery businesses – complete with Amazon-branded vehicles and uniforms, the Washington Post reported. Amazon will help keep startup costs to about $10,000 by offering discounts on vehicles, uniforms, fuel, and insurance coverage. Amazon is also setting aside $1 million to help military veterans interested in starting their own delivery businesses.
In India, in June 2018, Amazon went as far as launching Seller Lending Network, further scaling its Seller Lending program (launched in 2016), to offer sellers on Amazon.in loan options from multiple third-party lenders. With this launch, a seller can view multiple loan offers, apply for loans and make easy/automatic loan repayments by linking their Amazon sale proceeds to their loan account – all on Amazon’s Seller Central portal. Amazon launched in India in June 2013 with a few hundred sellers and currently, there are over 340,000 sellers selling on the marketplace. These sellers have listed over 170 million products on Amazon.in that get purchased by customers residing across all serviceable PIN codes in India. More than 50% of the 340,000+ sellers on Amazon.in are from non-metros. A total of 90% of the sellers on the marketplace use Amazon.in’s logistics and fulfillment services.
Internet/e-commerce companies are equally well-positioned to drive small-business lending in different parts of the world but the scale differs widely. Baidu’s microfinance unit, for example, last year applied for a quota to raise up to $602 million through issuing a form of securitization, called asset-backed note, in China’s interbank bond market. Chongqing Baidu Micro Finance is licensed as a non-bank microfinance company. In China, these companies have been filling the gap left behind by banks in lending to the underserved segments, such as micro-enterprises and SMBs.
A number of technology/internet companies are entering the SME lending scene and at this moment, they are perfectly well positioned to become the primary form a small-business lender, taking a whole market off the hands of not only financial institutions, but also alternative lenders.
It’s also reasonable to assume that tools such as Stripe Atlas, Holvi, and Estonia E-Residency for registering & running a business will play a significant role in reshaping small-business lending. Through integrations with marketplaces? They will launch own marketplaces? Who knows, but today they are going far beyond the lines of credit, enabling small businesses to focus on delighting their customers rather than drowning in intricacies of invoice management, vendor management, fraud prevention, etc.