#42 Predictions around African Fintech

Defining a framework for Fintech and applying this to predict some outcomes across key Fintech verticals

Hi all - This is the 42nd edition of Frontier Fintech. A big thanks to my regular readers and subscribers. To those who are yet to subscribe, hit the subscribe button below and share with your colleagues and friends. 🚀

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Introduction

8 years ago, around February 2013, I got the chance to attend my first ever Premier League game. It was my favourite team, Liverpool and they were playing Swansea at Anfield. The day turned out very well for me because Liverpool beat Swansea 5-0 with players such as Steven Gerrard, Coutinho, Suarez and Sturridge all scoring. Nonetheless, what stuck with me was not so much the result, but the fact that watching the team in the Stadium was a completely different experience to watching it on TV. There was so much more nuance that you can never experience from a broadcast.

Jamie Carragher and Lucas Leiva were both playing and both had dodgy reputations in terms of their footballing talent. Yes, Carragher was a club legend but many felt that his footballing ability was not at the level of top defenders. However, when watching the game in the stadium, I started to appreciate why many Liverpool coaches relied on these players. Their contribution was mostly seen off the ball rather than on-the ball. During moments when the opposing team had the ball, they would make subtle contributions such as asking a teammate to move two yards to the left so as to block off a potential passing lane. Or during a set piece, Carragher would instruct a teammate how to position himself in case a counter-attack materialises. 

Why have I gone on about this match and why Lucas and Carragher were so pivotal? The more I’ve interacted with people through this newsletter, the more I’ve realised that a lot of people are observing Fintech through their TVs rather than being in the stadium and watching the whole game. Some people are actually even watching YouTube highlights rather than watching the whole game. Subsequently some important events are being ignored and some players are being undervalued. Others who only shine whilst on the ball and only in some moments are being overrated. During this post, I will try to take a birds eye view on different elements within the African Fintech ecosystem and try to evaluate where things will go whilst trying my best not to give in to hype.

Context

Africa in principle seems to be the most exciting market for Fintech players and actually for many other industries as well. With a very young population and low levels of fixed capital formation as well as incumbent infrastructure, Africa is poised to be a continent where innovation can have outsized impact. Already, Mobile Money has been a great example. Where previously traditional infrastructure had failed to serve so many people, the Mobile Money revolution drove financial inclusion and enabled Africa to be an example on Mobile wallets. Similarly, China’s lack of incumbent infrastructure in financial services as well as retail enabled them to build giants such as Alipay, Alibaba and Meituan. As the Chairman of Ant Group Eric Jing said in the Ant IPO prospectus;

​​The financial system of the past 200 years was designed for the industrial era and served only 20% of the population and organizations. As we enter the digital age, we must better serve the remaining 80%. Together with our like-minded partners, our vision is that consumers and businesses will no longer have to navigate inefficiencies to find capital, but rather, capital will be matched with consumers and businesses based on data-driven predictive technologies, which will enable every consumer and small business in the world to benefit from tailored financial services. - Ant Group Chairman Eric Jing

The opportunity is massive and it’s only day 1. However, first is an important framework to have in mind in terms of value creation, the digital economy and what it means to be a technology company. Imagine being an economic planner, businessman or capital allocator back in 1890. A lot of modern technology such as steam engines, electricity and motorised transport were still in their infancy. Imagining how these technologies would impact society was a difficult task and there’s the famous quote by Henry Ford in which he stated “If I had asked customers what they want, they’d have asked for faster horses”. 

With the invention of electricity for instance, there was a lot of debate in the early 20th century about what impact electricity was having on production. In fact, it was argued that there was no improvement in productivity. However, over time, a young generation of managers realised that factories were not designed to take advantage of modern electricity. Factories were still designed around the centralised steam engine power source which was cumbersome and expensive. Productivity only improved when a new generation of managers figured out that factories needed to be designed around workbenches each with their own individual power supply. This drastically lowered costs whilst driving up productivity.

The video above is a great example on how electricity slowly drove multiple second order changes in how we live our lives.

Similarly, in the seminal book “The Box: How Container Shipping Made the World”, Mark Levinson traces the development of the container and its impact on the modern world. One of the pioneers of containerisation was Malcom McLean. In the book, the following passage really resonated with me;

“Malcom McLean’s fundamental insight, commonplace today but quite radical in the 1950s, was that the shipping industry’s business was moving cargo not sailing ships. That insight led him to a concept of containerisation quite different from anything that had come before. McLean understood that reducing the costs of shipping goods required not just a metal box but an entire new way of handling freight. Every part of the system - ports, ships, cranes, storage facilities, trucks, trains and the operations of the shippers themselves would have to change. In that understanding, he was years ahead of almost everyone else in the transportation industry. His insights ushered in a change so dramatic that even the experts at the International Container Bureau, people who had been pushing containers for decades were astonished at what he had wrought. As one of the organisation’s leaders confessed later, “We did not understand at that time a revolution was taking place in the USA.”

Essentially, the industrial revolution was not just driven by new technologies. The foundational insight was that the revolution was driven by changes in mindsets, organisational structures and design as well as a rethink on how surrounding infrastructure should be orchestrated so as to unleash the full value potential of these technologies. Similarly, given that the technology revolution is still in its infancy, most people haven’t yet realised the potential disruptive forces at play. Some have “applied” these new technologies to their operations, but the biggest disruptive forces will come from those who organise around the technology i.e. those that become technology companies across all verticals. 

Two insights from the Nubank IPO prospectus stick out. One on what it means to be a technology company and the second on what will be the impact of being technology companies. On what it means to be a tech company, Nubank breaks it down to a few elements;

1. Customer centricity -  intentionally and deliberately building a culture that is obsessed with customers;

2. Focusing on Customer experience - whilst related to the above, there should be a focus on creating simple to use products that are easily integrated. The first is around focusing on solving the customer's problems, the latter is more of how the customer should interact with your solution;

3. Advanced technology - Nubank has built out a proprietary technology stack. Nonetheless the point here is to lead with technology and put technology decisions at the heart of commercial strategy;

4. Data and Data science - Leaning in on data to power all your decisions and embedding it as a factor of production. Shien is a great example on how a traditional industry such as fast retail can be driven by tech;

Lastly, is the nature of labour relations. That sounds super stodgy but it’s critical to understand. A modern tech company focuses first on recruiting only the best talent across the board but also creating an ownership culture amongst the employees. Nubank for instance has recruited from over 48 nationalities and over 70% of its staff are shareholders. The graph below shows what is the ultimate outcome in terms of focusing on being a tech company;

Source: Nubank IPO Prospectus

Nubank’s complaints per 1 million customers is magnitudes of times less than the incumbent competitors whilst its cost to acquire customers is also significantly lower.

Lastly Nubank’s IPO mentions something that has been mentioned by Softbank, Tencent, Tiger Global and basically everyone else in global tech. 

"We believe new technology-driven companies can capture market share from legacy providers across all industries, expand the size of addressable opportunities and operate with superior economics.”

Essentially as I review these industry vectors, the questions will be based on which players are organising as technology companies (which are expected to win in the long-term), ensuring that I’m watching the whole game and not the highlights and understanding how tech should be deployed.

Looking Ahead

Consumer Fintech

Consumer Fintech is a very interesting vertical right now. Chipper Cash recently raised US$ 100m at a valuation that has been mentioned to exceed US$ 1 billion with some saying that it’s the most valuable African Fintech. Earlier in the year, Wave raised a whopping US$ 200m Series A that valued it at US$ 1.7 billion. I did an article on Wave where I asked whether we’d be saying goodbye to Telco led Mobile Money. Recently, Safaricom released its HY 2021 results which showed that for the first time, M-Pesa revenues exceeded traditional voice revenues.

The race for the consumer in Africa in my view will be based on three key sub-vectors. Full-stack Mobile Money e.g. M-Pesa and MTN Money, full-stack digital mobile money e.g. Wave and interface driven players such as Chipper Cash and Kuda. Indeed it may be a misrepresentation to state that players such as Chipper Cash and Kuda are interface only, they have invested heavily in the underlying payment infrastructure such as payments and APIs. 

For this race, one has to take a long view and predict how events will unfold over the next 10 years. The key competitive factors will be;

1. The reliability of the platform and uptime statistics - arguably the most important element;

2. The ability to solve customer problems intuitively with useful user experiences;

3. The ability to attract the best talent across engineering, data science, design and sales;

4. The ability to serve the African consumer efficiently

As regards to the last point, there should be a core reality that the African market largely consists of low income people with a GDP per capita of around US$ 1,500 and a median age of 19.7 years. In addition to this, Africa is a predominantly cash economy with over 95% of transactions occurring through cash. 

If you imagine a ranking system based on the above factors. You can tell that modern players such as Chipper and Wave will do well in solving customer problems and attracting the best talent given their corporate structures. MoMo will do well in the ability to serve African consumers particularly from a CICO perspective and also reliability which is their biggest weapon. Wave is building CICO in all the markets it's entering and that’s why it's a full-stack solution. The CEO of Safaricom has often mentioned that his strategy will include transforming Safaricom into a technology company so he must at least get credit for understanding the importance of this culture shift.

I may be biased but I think the Wave model could be a winner. They’re doing the ugly hard work of building cash infrastructure whilst being a true tech company in terms of recruitment, culture and core tech expertise. I foresee a situation where together with their investors Stripe, they could build the capabilities to power global payments via their continental CICO infrastructure. So imagine having Wave as a payment option for an African employee who works for a global company. This employee can have the option to cash out from an agent using a QR card or a pass code that can only work through a Wave agent. They can additionally embed Crypto once it scales. It will be interesting to see how their expansion into Uganda works but from what I hear, they’re having a great time rolling out into Anglophone Africa due to the commercial cultures that exist and the fact that Regulators are easier to deal with.

Part of the “under-valuation” that exists with traditional mobile money is based on the fact that MoMo brands can't scale across the continent. The MoMo business is tied to the Telco business and the Telco business has succeeded on legacy considerations such as even colonial legacy. Why does Orange do well in Francophone Africa and Vodafone succeed in Anglophone Africa?

Future of Banks

I don’t have much to say as regards to banks. Nonetheless, I feel that incumbency is so entrenched into banking culture and baked in even further through regulation. My view of the banking industry is built on the idea that technology has changed the economics behind how banks are structured and how they serve their customers. Branch based banking was the original iteration. Due to the cost pressures around this, banks could only serve specific clientele and thus exclude many others. Bank of America and Wells Fargo were global pioneers in expanding banking services to the masses but even this had its limits. In Africa, Equity and GT Bank innovated at the margins in terms of lower cost branches, ATMs and operational structures. 

However, as technology advances particularly APIs and cloud computing, then the logic behind how banking services are delivered are having to change. Banks have responded in two main ways. On one hand, some banks have decided to take the fight to Fintechs by building out their own consumer propositions. Globally, the likes of JP Morgan and Goldman have launched consumer propositions. Marcus by Goldman is a great example. DBS has launched Digibank in most of the markets in which it operates. On the other hand, some banks have retreated into the background to focus on being an enabler through embedded finance and Banking as a Service. Players such as Cross River and Solaris Bank are great examples.

Goldman has hedged its bets by building out both i.e. having world class BaaS infrastructure whilst building out its consumer proposition. This document shows its thinking around Embedded Finance and why they think they’re well placed to win in that space.

If banks cannot become tech companies in terms of their recruitment practices (giving equity to top staff), being consumer centric and leading with tech which is related to recruitment; then over the next 10 years, what is likely to happen is a retreat into banking as a utility i.e. money storage and movement infrastructure. This is likely to favour scale players who have the balance sheets to support things such as embedded finance. The banking sector in Africa is thus likely to continue consolidating with big four utility-like banks emerging in most markets. Think for a moment about Stripe, Stripe started by enabling smaller companies to accept payments but over time larger companies are using Stripe’s infrastructure. Banks have then lost business in terms of merchant acquiring and now only receive payments.

Lending

There’s general consensus that credit markets in Africa are underdeveloped. The percentage of adults who have borrowed from a financial institution is still very low. In Nigeria for instance, only 5.2% of adults have borrowed from a financial institution compared to a global average of over 40%. In Kenya this is relatively high at 19.2% driven by innovations such as M-Shwari and Fuliza.

Different approaches to lending have been attempted. The likes of Tala and Branch led with digital algorithm driven lending, focusing on the use of “alternative data sets” whilst using digital enforcement capabilities such as sending SMS’ to your close relatives to pressure them. This of course failed spectacularly when Covid happened. In colloquial Nairobi slang, there’s a saying that “Punda pia huchoka” which means that “the donkey also gets tired”. In essence, people got tired of the pressures to pay coupled with the threat of negatively being listed and defaulted on their obligations and adopt an “I don’t care” stance.

From my experience, lending in Africa is largely driven by the ability to collect repayments or from your defaulters rather than identifying who to lend to. The algorithms are not of much use if you cannot collect. Companies such as M-Kopa Solar have learnt this the hard way. M-Shwari succeeded not only due to the threat of being listed but by threatening defaulters with the risk of losing your transactional identity i.e. you could lose access to your M-Pesa and thus access to your financial life if you defaulted. MoMo’s that don’t have dominance in market share have experienced crippling defaults in their digital lending propositions.

A loan is a claim on future income and an African has multiple claims on his future income such as unexpected emergencies, school fees, sporadic food prices and many other factors. Loan repayments rank very low in terms of his/her financial priorities and thus the game is always based on the ability to pressure someone or force collection. In Africa this can be tied to networks such as associations which have control over a transactional identity e.g. a market based womens saving network.

My view is that the winners of the lending space in Africa are those that will create transactional infrastructure that is rentable by groups that can handle collections i.e. enabling informal groups to access a balance sheet, underlying technology e.g. ledgers and payment systems whilst handling collections. Kwara for instance is doing this by digitising SACCO’s which are groupings that drive repayments from their members. 

In the future, players such as Goldfinch that enable collateralized lending on DeFi can also work where Africans can stake their crypto and access low cost loans.

Embedded Finance

The video above by Angela Strange, a partner at a16z gives the outline of how every company can become a Fintech. The idea is that financial services through APIs can be intuitively built into different customer propositions. Some of the best examples of Embedded Finance have been executed by Shopify and Amazon where Shopify now generates more revenues from payments than it does from its merchant services. 

Embedded Finance has the promise of enabling companies to increase margins whilst offering a better customer experience. Embedded Finance then falls into a number of sub-verticals such as;

1. Embedded Payments;

2. Embedded Insurance;

3. Embedded Lending;

4. Embedded Banking; &

5. Embedded Investments;

According to a study by Accenture and Plaid, revenues from embedded finance in the USA are projected to hit US$ 230 billion by 2025. 

In Africa, Pezesha and Twiga have partnered to launch embedded finance for Twiga merchants and it will be interesting to see how this plays out in the long-term. 

My general view on this space is that on one hand, a lot of the pressure to have embedded finance is based on VC thinking i.e. every VC wants its investee companies to “embed finance”. On the other hand, the biggest question should be “where should finance be embedded to have the biggest impact?”. It should start with understanding the customer's problem and thus embedding finance where necessary. A lot of finance is being embedded in the wrong places and this should be the focus over the medium term from operators and VCs alike in Africa.

Crypto and De-Fi

I did a two part series on DeFi a few weeks back. The promise of Crypto and DeFi particularly in Africa can be reviewed here and here. The biggest issue is around regulation with a particular focus on Nigeria and Kenya where regulatory attitudes have been the toughest. These two markets tend to set standards and guidelines that are often adopted by neighbouring countries. Over the next 10 years, I expect crypto to move from being completely banned to being approved in a controlled manner. 

The immediate impact will be around cross-border payments and remittances. Companies such as Chipper Cash are preparing for this with a view of being the front-end for African Crypto. The next phase should be around institutional crypto where players such as FTX and Coinbase have done an amazing job. 

Wrapping it up

Often predictions often tend to embarrass the person making them and these could come back to haunt me. However, we often need to make a bet on how things will turn out both as operators and investors. I’d love to hear your input into some of these predictions.

As always thanks for reading and drop the comments below and let’s drive this conversation.

If you want a more detailed conversation on the above, kindly get in touch on samora.kariuki@frontierfintech.io or samora.kariuki@gmail.com