By Karel Cool and Olivier Daviron
French-born Renaud Laplanche founded LendingClub, the marketplace lender that connects borrowers and investors through its online platform, in 2007. The idea had its origins in his early days at a previous venture, TripleHop, when he had purchased office supplies using his credit card because there was no alternative means of finance. It occurred to him that investors would be willing to step in and provide funding at preferential rates given that he was a low-risk borrower. By cutting out middlemen and matching borrowers directly with lenders, Laplanche and co-founder Soul Htite believed that they could achieve a better outcome for both sides. In May 2007, LendingClub launched as one of Facebook’s first applications, attracting buzz and young borrowers with scant credit histories.1 When Laplanche left the company in May 2016, its loan portfolio was valued at close to $20 billion.
Using marketplaces like U.S.-based Prosper (founded in 2006) and UK-based Zoppa (launched in 2005), individuals and businesses can request loans for a variety of projects such as credit card debt consolidation, home improvement, short-term and bridge loans, vehicle loans, etc. These requests are then screened and typically segmented into different risk levels. Investors (individual or institutional) can then examine these loan bids and decide what to fully or partially fund. These loans tend to be for a period of one to five years and amount to less than $35,000 for individuals (up to $300,000 for businesses).
An estimated 111 marketplace lenders now operate in the U.S.2 Combined new loan volume for the USA for LendingClub, Proper, SoFi and OnDeck in 2018 is expected be $38.9 billion, a year on year increase of 46%.3 Many financial institutions have been deleveraging in the aftermath of the Financial Crisis, making it more difficult for customers to get personal loans and creating an opportunity for marketplace lenders.4 For many investors, companies like LendingClub provide access to an asset class, consumer lending, that was previously inaccessible.
Marketplace lending has grown at an estimated 51% CAGR5 in the U.S. in the period 2015-2018 and continues to attract capital.6 Despite this trend, few P2P fintechs have made it to IPO; those that have are performing poorly. When bellwether LendingClub listed in December 2014, it opened at $24.70 per share. It has seen its stock erode to just $3.95 per share of March 16th, 2018.
In May 2016, co-founder Renaud Laplanche was forced to resign following some governance issues. There is debate, however, whether the stock price decline of LendingClub reflects issues at the company or more fundamental weaknesses in the business model, such as the imitability of the business model, competition from banks, the strength of the first mover advantage, weak network effects, the commoditised nature of personal lending, etc. Earlier this year, M. Laplanche discussed many of these issues in an interview by Karel Cool, Professor of Strategy, and BP Chaired Professor of European Competitiveness at INSEAD.
Renaud Laplanche founded the new marketplace lending platform Upgrade in April 2017, funded by some of the original investor in LendingClub (LC). On October, it completed a $282 million securitisation. Since its founding, it has already facilitated over $1 billion in loans.7
When LC, Prosper and others started, they were labeled as “disrupters”. Did you see LC as a disrupter or challenger of the banking industry?
We called ourselves disrupters at the time and we still do. And I think there are many different flavours of disruption. You’ve got the kind of disruption where you try to break everything and you go head-to-head against the incumbent. And there are also more gentle type of disruptions that could be just as powerful, but don’t necessarily need to break everything else. You can partner with incumbents in a way that’s more symbiotic. One example would be the online music sharing industry. Napster was initially the disrupter but did so in a way that just wasn’t in compliance with the existing legal framework and was really a head-to-head confrontation with the music industry. Then you’ve got Apple iTunes that really found a way to do the same thing in partnership with the music industry and it really achieved a much more profound transformation by getting to scale.
So I think marketplace lending went through the same phase, but we went directly to the Apple iTunes’ model where we decided to partner with banks in a way that was a lot more symbiotic.
What challenges did you face as a pioneer?
When we launched LendingClub about ten years ago, it was in 2007, and after 2007 as you know comes 2008 and obviously there was the major financial crisis. It was really interesting to launch a new credit concept in the midst of a major credit crisis. And I think it was good and bad in hindsight. We were helped by the crisis on the borrower side. LendingClub is a two-sided marketplace: you’ve got borrowers on one side, investors on the other side. […] there was a credit crunch and borrowers needed a different source of credit to turn to. That helped marketplace lending get off the ground. But on the flip-side we were trying to sell to investors the idea of investing in consumer credit at a time when they were opening the newspaper every morning and looking at headlines about Americans defaulting on their mortgage. So that clearly wasn’t helpful.
In all I think the crisis helped expose some of the flaws of the banking system. It was helpful to us in the long-run but it really made the investor side slower to take off and it took us a good three to four years to really establish our own track record with investors and show that we could underwrite and service loans in a way that gave an attractive return to investors.
As one of the first marketplace lenders, did you achieve first mover advantages? Which?
A first mover advantage in marketplace lending and credit in general is probably different from a first mover advantage that you get in a typical technology product or consumer product enabled by technology. The first mover advantage doesn’t necessarily translate into, “Hey, we have the product first and we can drive adoption and we’d get to market – to a large market share before anybody else does.” I think the first mover advantage translates into the clock starting earlier on the track record. Marketplace lending has two sides, borrowers and investors, and what really matters to investors is track record. Investors look at past performance [to] estimate […] what future performance would be. Being able to start earlier than anybody else and have more data and a longer track record is an amazing competitive advantage because the only thing that you can’t buy is time, essentially. So any new entrant coming in with even a lot more resources just can’t manufacture a track record. It’s something that LendingClub and Prosper would always have. It’s a longer track record, more data than new entrants. So I think it is a pretty key competitive advantage.
Did LC have to scale high barriers to entry?
Barriers to entry work both ways. It’s hard to get in, but once you’re in, it’s a nice protection against new entrants. I think in general, marketplace lending and FinTech have lower barriers to entry than traditional banking. [Consumer lending] is a highly regulated industry, but not as much as traditional banking. If you take marketplace lending for example, a lot of consumer protection regulations apply to marketplace lenders the same way they apply to banks. But there is an entire set of regulations that doesn’t apply to marketplace lenders – Everything that has to do with the Basel III norms. Everything that has to do with a reserve requirement, with FDIC insurance in the U.S., with the capital adequacy ratio. All of that does not apply for a good reason because marketplace lenders don’t have their own balance sheet and they don’t take deposits, so they do not put deposits at risk. In general, marketplace lending is a capital-light situation. So there are higher barriers to entry than the next photo-sharing app, but less than for banks and insurance companies.
Analysts disagree on whether marketplace lenders are similar to platforms like Airbnb, OpenTable, Uber, etc. What similarities do you see with these platforms? What key differences are there?
I would make the case that marketplace lending is absolutely a two-sided market. I think because of the nature of the assets, we probably have to do more [than the typical platform]. There are “thin” intermediaries, such as Craigslist which is a great two-sided marketplace, which is a job posting or ads posting site, and they don’t do a whole lot in terms of organising that marketplace. Clearly marketplace lenders are a “thicker” intermediary and they do a lot more in terms of marketing to borrowers, in terms of underwriting loans, of pricing loans and servicing loans. And on the investor side, there’s another layer of intermediation in terms of institutional investors who essentially raise capital from individuals and manage these funds and then invest whole or part of the funds on the marketplace. So it’s fair to say that there are more layers of intermediation and that these are thicker layers than in other online marketplaces. It’s really made necessary by the fact that these are financial services and I think our users hold us to a higher standard than they would if they were just using Craigslist.
Prosper, when they got started, did a lot less [than LendingClub]. There was very little pricing – it was more dynamic pricing based on supply and demand. There was initially no underwriting at all. It was really a thin marketplace and that experiment didn’t work out well at all and I think Prosper became more and more like LendingClub at the time.
Some analysts have drawn comparisons between monoline lenders such as Northern Rock from the UK (mortgage lender) that got in trouble in the 2007 crisis and marketplace lenders. What similarities and differences do you see?
Marketplace lending has been compared, I think inaccurately, to monoline lenders that caused the financial crisis of 2008. There were many causes to the financial crisis, by the way. The comparison is inaccurate and marketplace lending is almost the opposite of what happened in 2008. What happened in 2008 was a diffused chain of accountability where you often had mortgage brokers that started a relation with consumers, then the brokers referred the loan to the bank in which the loan was originating, then the bank hired a loan servicer who had to service the loan, and often sold that loan to an investment banker who packaged that loan, chapped into pieces and then sold the pieces to small towns in Norway, and rating agencies giving them generous ratings. At the end of the day there was no clear accountability of performance. There was a very diffused chain of responsibility.
Marketplace lending is the exact opposite of that. It’s completely integrated. We are responsible for marketing to borrowers, for putting together the product, for underwriting the loan, pricing and grading the loan, and for servicing the loan. If it does not perform, it is us. There is nobody else we can point fingers to. That puts a lot of burden accountability on us to make sure the loan performs. If the loans do not perform, it does not matter if it is our balance sheet or not; it is us. The investors hold us accountable for it and won’t buy again.
Is the personal loan business essentially not a commodity business where returns inherently are unattractive?
Loans are sometimes mistakenly described as a commodity. I think it is a mistake. Money is a commodity. The experience of getting a loan is not and we see that all the time. I can share with you many customers’ emails and phone calls that explain how well they have been treated, how they liked the process of getting a loan, how it was easier, faster. Sometimes customers come to us because of our price advantage, and clearly we have a lower cost of operations and that helps drive prices down. But it would be a mistake to consider this the only element of differentiation. The experience of getting credit is sometimes intimidating to some people and a lot of people think they are asking for money and it is not a comfortable situation to be in. Being on the receiving end of this and making that experience better and less stressful and less intimidating is, I believe, a key factor of success.
What opportunities do you see today for marketplace lenders?
Over the last ten years we have really established that the business model was working, that using modern technology will help lower cost and that borrowers would benefit in the form of lower interest rates; investors would benefit in the form of attractive returns. So, we could lower cost and deliver a better experience. But, I think, collectively, as an industry, we’ve only scratched the surface in terms of the types of products we can deliver and the penetration within financial services and banking. If you think of, even, the initial opportunity of refinancing a credit card balance, there’s now, in the U.S., about a trillion dollars in credit card balances. The industry is probably generating $20 billion a year, so there’s a lot more that can be done there and then there are a lot more products that can be created that can be helpful to consumers.
What are the major challenges that marketplace lenders face today and in the next five years?
One of the key challenges for Upgrade and for any marketplace lender is to really change pretty profound habits that have been formed by consumers over many decades of banking. Clearly, we’ve changed some of them. We’ve brought back the personal loan product; that’s better than a credit card for a lot of consumers. But there are still a trillion dollars in credit card debt and less than $100 billion in personal loans. So clearly, there’s more work to be done in terms of educating consumers. And that work is going to have to be done for every single product. So, when we launch mortgages, auto loans, we’ll have to explain why we can provide a better experience and lower cost than the banks can.
We don’t have a branch at every street corner, so that certainly gives us a lower operating cost. That also limits our reach. I think it also limits how visible we are. [There is] a confidence and trust factor in financial services. Seeing a branch at every corner reinforces that feeling that it’s safe and it’s there; it exists, I can see it and I can touch it.
So, we need to be particularly vigilant and have even higher standards online in terms of transparency, in terms of establishing credibility, and in terms of doing what we said we would do and delivering an even better service to overcome the confidence and trust advantage that the banks have been building for many decades.
About the Authors
Karel Cool is a Professor of Strategic Management and the BP Chaired Professor of European Competitiveness at INSEAD. His research, teaching, and consulting focus on problems of industry dynamics and competitive strategy. Karel Cool is directing the Competitive Strategy Executive Education programme at INSEAD.
Olivier Daviron is an MBA graduate of INSEAD in 2012 and Strategy Director at Genscape.
References
1 http : / / www.forbes.com / forbes / 2010/1220/investing-lending-club-credit-cards-personal-loans-for-fun.html
2 D. Perkins, Marketplace Lending: Fintech in consumer and small business lending, Congressional research Service, September 2018
3 https://www.lendacademy.com/altfidata-predicts-strong-growth-marketplace-lending -us-2018/
4 There is an extensive literature, but see for instance A, Morse, Peer-To-Peer Crowdfunding: Information And The Potential For Disruption In Consumer Lending, 2015, NBER Working Paper 20899; B. Vallee and Y. Zeng, Marketplace Lending: A New Banking Paradigm, 2018, HBS Working Paper 18-067; Jean Dermine, “Digital banking and market disruption: a sense of déjà vu?”, Financial Stability Review, April 2016.
5 IBISWorld, Peer-to-Peer Lending Platforms in the U.S., September 2018.
6 Global Fintech Report Q3 2018, CB Insights.
7 https : / / www.upgrade.com / press – release – upgrade – completes – 282 – million – securitization.html
