In a sea of Fintech ‘Unicorns’ that bleed red and burn through $billions of VC money, one company stands out – OakNorth Bank. As Europe’s most valuable unicorn, we will look at how they have managed to become profitable in only a few short years and how Business Model Innovation gives them further runaway against both Fintechs and incumbent FIs alike.
What is OakNorth?
OakNorth is a digital-only challenger bank that lends to SMEs (Small and Medium Enterprises) and sells mortgages to a select group of customers.
As entrepreneurs in a high-growth SME themselves, OakNorth’s founding team – Rishi Khosla and Joel Perlman – saw the problem from a very unique angle. They saw the pressures being put on local branch managers by behemoth banks, and the corresponding effect on local SMEs who were unable to raise capital without the security of a personal mortgage.
Their solution was to platformize the loan process, which cut down both the time it took to process a loan application from months to days and enabled them to use advanced data-science techniques to assess the creditworthiness of prospective clients. The results have been astonishing. They have lent out more than £3bn to UK businesses with zero (technical) defaults or late payments since 2015!
To attract savings customers they offer competitive rates for their savings accounts, and in-turn they lend out that money to SMEs, pocketing the differential in interest rates.
How Does it Work?
Prospective businesses fill out a form with the basics of any credit application:
- how much they are looking to loan
- what term they are looking for
- information about their business (ie. headcount, revenue, margins, etc)
OakBank’s AI platform processes the application, which is then sent to a Credit Committee that will approve or deny the loan. The entrepreneur or executive is able to attend the meeting, and the decision is made.
Once the loan is granted, the platform continues to take it data to monitor for potential flashpoints:
While the company has had no technical defaults on the books, they admit they have modified the terms on certain loans and sent poor performers to refinance at other banks, where they have subsequently defaulted.
Who Uses It?
On the lending side, high-growth businesses in the UK looking for between £500K and £40mn.
Outside of the UK, the company has white-labeled its tech platform – OakNorth AI – and are licensing it out to regional FIs (financial institutions) in various local markets who will leverage it on their own customer base.
With their upcoming US expansion, they are looking to setup the Lending Business Unit – as they would in the UK – but use the other banks’ balance sheets to underwrite the loans. Similarly, we should expect a similar customer profile – high-growth SMEs – with the potential for certain regional differences that slightly change the profile of the customer base. But in this case, as they will be using other banks’ capital, they don’t have to build up the base of savings accounts to fund the loans.
On the lending side, the company doesn’t advertise, as most of their growth comes via referrals and renewals:
This is probably what separates them from their Fintech peers, who burn through the majority of their money on customer acquisition costs. With a low CAC (customer acquisition cost) – the company still hosts events, etc – they can offer competitive rates, which in turn generates good ARPU (average revenue per user) and a high LTV (lifetime value) because of the loyalty factor.
The company had pre-tax profits of £10.6mn in 2017 and £33.9mn in 2018, but has raised an additional $440 million from Softbank earlier in 2019 to fund its US expansion. This expansion will give them another revenue stream – B2B – and create further opportunities to leverage network effects for customer acquisition.
Competition in the SME lending space is fierce, both among Fintechs and incumbent FIs. But competition in this space generally comes down to a few key factors:
- cost of capital
- cost of customer acquisition
- default rate
OakBank is Europe’s ‘most valuable Fintech‘ for a reason. They are able to use technology to minimize defaults and their loyal customer base to minimize customer-acquisition costs. While they don’t have the balance sheet of the big banks, they have enough capital to loan out at competitive rates to compete on cost of capital. Combined, it is a formula that can withstand a sustained downturn, like a recession:
Therefore competition from other challenger banks or VC-backed Fintech firms with a big war chest seems unlikely. Especially since OakBank already has a proprietary technology stack that has been trained through hundreds of thousands of loan application and millions of data points.
Competition is likely to emerge from mid-size to large banks. Goldman Sachs, for example, has launched its Marcus product in the UK, which had signed up more than 50K customers within the 1st two weeks of UK launch and had more than 250K customers by Q2 2019. The product offers high-interest savings accounts and personal loans – for now. As of Q2 2019, they had $46bn in deposits globally and had lent out more than $5bn. It’s easy to see how Marcus could spin out a product that takes on the SME market directly in the future, but it’s likely a market that is big enough for many players.
On the European side, Santander Bank partnered with Kabbage – another Softbank backed SME-loan platform – to power its SME lending business across Europe. At the time of launch in Q2 2016, the loan amounts were much smaller (£5,000 – £100,000) and meant to ‘be made in minutes.’ Clearly though, since both platforms were in the market at the same time, simply being ‘powered by’ a fintech platform will not give big banks enough of an advantage to overtake OakBank in the UK market.
With Oakbank’s strategy is to expand by licensing OakNorth AI into the US and other markets, they can continue to focus on a very customer-oriented strategy in the local UK market and leverage their partners’ relationships and balance sheets in future markets.
Furthermore, they continue to expand their data-aggregation and analysis capabilities through partnerships with partner FIs, like Dutch-based IBC Bank, who recently signed a 5-year contract with OakNorth to onboard its mid-sized clients and automate layers of the lending process to make the business more efficient.
Overall, we see an excellent example of Business Model Innovation; OakBank has built a strong and profitable lending business in one market, but is licensing the technology to expand into other markets. Since they are already profitable and have a ‘bunker’ mindset in relation to future recessions, it seems that it will be very difficult to stop OakNorth from becoming a bellwether Fintech that grew out of this decade to serve a large customer need and become sustainably profitable.
What is Business Model Innovation? Innovation using the Business Model as the main mechanism, rather than product or technological innovation. Reinventing a business model – or creating a new one – is a matter of remixing the core components of a business model and developing new value propositions, revenue streams, and cost structures.