Monzo is a UK-based, digital-only Challenger Bank – one of the fastest-growing among Revolut, N26 and others.
- How does Monzo make money?
- Community-Centric or Commercial-Partner Strategy?
- Fundraising and Valuation
- Monzo Business Model Canvas
- Monzo Business Model Analytics
- 2020 – A Blow to Monzo’s Bottom Line
- 2021 – Monzo Doubles Revenue, Diversifies Streams
- 2022 – Carnage for Digital Banks, Monzo has Ups & Downs
- Monzo Outlook – 2023 and Beyond
- Top 3 – Learn More
3 in every 100 people in the UK use Monzo, and with a US launch on the horizon, it’s time to analyze how Monzo’s strategy translates into top and bottom-line growth using the Business Model Canvas!
How does Monzo make money?
The 1st question is, is Monzo a bank?
Technically the answer is yes, given that they have had their UK Banking License since Q2 2017. But practically speaking, they don’t operate like a traditional bank.
They are a ‘Challenger Bank‘ operating at the margins between an online Chequing/Savings accounts and a virtual financial planner. And while traditional banks have a hybrid between bricks-and-mortar branches and online services, Challenger Banks are digital-only.
Traditional banks make the bulk of their money by underwriting mortgages, commercial loans, and lines of credit, pocketing the NIM (Net Interest Margin) between the cost to borrow versus lend out. Challenger Banks like Monzo do not.
Monzo has multiple revenue streams:
- Offering Premium Accounts – Monzo Plus – ranging from £4.95 – £12 per month on 6-12 month contracts, which comes with benefits such as travel insurance, etc depending on the package you select
- Providing Overdraft Protection to customers for a small monthly surcharge (50p) up to a max of £15.50 per month
- Creating interest-bearing Savings/ISA Accounts with OakNorth Bank where Monzo pockets 30-40 bps depending on the product
- Interchange Fees earned on each transaction on their platform, with an estimated Transaction Take Rate of $0.20 per transaction made on their platform (paid by the merchant)
*They recently put the brakes on plans to launch Business accounts (which competitors like Revolut already have) due to losing out a grant, but will undoubtedly have those in the future.
Clearly, Monzo has been growing like wildfire since their inception. Similar to other Challenger Banks (+ N26 Business Model & Revolut Business Model) they are not profitable, instead preferring to maintain hockey-stick level growth and charting a ‘future path’ to profitability.
Community-Centric or Commercial-Partner Strategy?
Monzo is a hybrid between a community-centric and a commercial-partner strategy. Similar to UK-based Revolut, they launched using an equity crowdfunding campaign and have built a significant following in their forum Monzo Community.
But in other ways, they are more like N26, deciding to strategically source out partners in other niches (ie. Oak North) and markets (ie. US Market Entry).
The bank started as a pre-paid debit card. The team generated hype for its sleek app with a lengthy waitlist, and that whiff of exclusivity operated as a cunning customer lure. Wannabe customers could jump an initially lengthy queue if friends granted them one of their few “golden tickets”. Demand swelled, allowing Monzo to grow its user base exponentially despite spending virtually no cash on marketing up until this year.The Guardian
Monzo’s original equity crowdfunding campaign in Q1 2016 was syndicated with Passion Capital and subscribed for £1mn in under 2 minutes! In Q1 of 2017, they launched a 2nd equity crowdfunding campaign, which was once again oversubscribed to the tune of £12mn.
Then in Q4 2018, they launched yet another equity crowdfunding campaign, raising £20mn from ~36,000 customers in a matter of hours. In this light, we can see that the equity crowdfunding creates a ‘Growth Flywheel’ of sorts, as the funds come from customers themselves, creating engagement, feedback loops and funds to expand all at once.
But Monzo has also been active on the partnership front. Partnering with other UK-based challenger OakNorth has allowed Monzo to expand into the league of ‘banks’ by generating revenue off interest rates, in this case, 0.30-0.40% through this partnership with OakNorth Bank.
They are also taking the partnership route in their planned expansion into the US, but will not offer lending to US customers, instead focusing mostly on in-app features around spending, savings, and payments.
Part of Monzo’s explosive growth has been linked to their highly-rated Customer Support. This is another area where they may have to partner, as they recently had job ads on LinkedIn for Customer Support positions in Las Vegas. Understanding and adapting to local-market conditions will likely be essential for long-term success as a global bank.
Fundraising and Valuation
Monzo’s most-recent fundraising round in Q2 2019 valued the company at $2.5bn USD with a $144mn investment from a group of investors led by Y-Combinator. The valuation is similar to that of other hyper-growth Challenger Banks.
The branchless bank is now making £4 on each customer it signs up to the platform, versus a £15 loss per customer last year, according to a company spokesperson.CNBC
Similar to its peers, Monzo is comfortably operating at a loss (£33mn in 2018) with a strategy of expanding its footprint in the global market before focusing on profitability.
“Getting to profitability is not a goal we are prioritising over delivering customers real value. If that takes 10 years, we are committed to it.”The Guardian
The company currently has more than 1,000 staff, but will likely continue to need to add significant headcount as it rolls out to new markets and deals with increased competition.
Monzo Business Model Canvas
A business model is defined as:
Alex Osterwalder et al invented the Business Model Canvas to help individuals and organizations conceptualize how to analyze, create, and develop business models.
Monzo Value Proposition
A new Marketplace-Model of Digital Banking
- Core app helps users save money, manage budgets, easy transfers
- Offers Savings/ISA accounts, travel insurance and other services via Partnership
- Top-notch customer support
Monzo Business Model Analytics
Monzo’s rapid growth in its early years can be attributed almost solely to word-of-mouth and referral marketing, driven by a deep loyalty and excitement in the community.
By early 2018, Monzo had approximately 500,000 users, almost all of whom the company had acquired organically via referral,NetGuru
This is the type of network profile that typically leads to rapid growth and cheap CAC (Customer Acquisition Costs) relative to other competitors. Transferwise (Wise) is another UK-based Fintech that we saw this strategy applied with.
From organic marketing alone, Monzo was growing at a rate of 50,000 – 100,000 users per month in 2018/2019. In early 2019, they began to switch their Channel mix towards paid.
Whether or not this new Paid marketing strategy worked, long-term, is open to debate, but when we look at Monzo’s P&L we can see the massive expansion of their Operating Cost base/Losses in 2019 and into 2020.
Without knowing every detail about the Customer Analytics, we can see from 2020’s performance that they were unprofitable on a per customer basis relative to their CAC. As we discuss below, some of the big losses were for factors Monzo could control, and others for which they couldn’t.
2020 – A Blow to Monzo’s Bottom Line
Going into 2020, Monzo was still at the top of the Digital Banking heap. Then their fortunes started to reverse and they found themselves in search of real revenue and a move towards profitability.
If we look at Monzo’s 2020 Annual Report, we can see that their top-line revenue and other headline metrics looked rosy in 2020.
But their more important ‘financial health’ metrics for a banking entity took a sharp decrease as Monzo got heavy into the lending business. They ramped up lending, and their Tier 1 Common Equity Ratio – a key indicator of financial health for banks – cratered in the process.
When they released their FY 2020 Annual Report (in mid 2020), things were so bleak that their ability to sustain their business as a ‘going concern’ was in question.
The start-up reported an annual post-tax loss of £113.8 million ($149.5 million) in its 2020 accounts, up from the £47.1 million it lost last year, amid investment on hiring, marketing and a U.S. expansion. That was despite revenues more than tripling to £67.2 million from £19.7 million.CNBC
In summary, Monzo’s core business model took a huge hit in 2020 because:
- Interchange Revenue decreased significantly due to the onset of the pandemic
- They had removed their Monzo Plus account in a bid for growth, and lost that as a revenue stream (they ultimately relaunched it in mid 2020)
- In a somewhat desperate bid for revenue, they lent out to customers in a questionable way and ended up taking huge credit losses
But it expects credit losses to climb dramatically to £20.3 million from £3.9 million, with £4.1 million of that sum being set aside for a heightened default risk associated with the pandemic.CNBC
This was on top of the capital they were burning on their U.S. Expansion strategy, which ultimately failed.
This was not necessarily an atypical position for the top UK Challenger Banks during the early days of the pandemic, but each company took on a vastly different strategy:
- Revolut doubled-down on what it was doing – despite the sharp decrease in Interchange Revenue – and moved heavily into Cryptocurrency Trading, a move that paid off well
- N26 realized they were spread too thin, strategically, and ultimately exited the UK market. They tried to enter the US market right after, only to end up leaving a year later
- Monzo – a company with only UK customers, none from the EU – went into lending and ultimately paid the price
As a result, Monzo saw its valuation fall in 2020 while Revolut and N26’s continued to rise. The company raised money at a $1.6 Billion valuation, a 40% haircut.
2021 – Monzo Doubles Revenue, Diversifies Streams
12 months later – at the end of 2021 – Monzo was back on the up-and-up with a new fundraising round valuing the company at $4.5 Billion Q4 ’21, a nearly 3X bump in valuation. This is in line, however, with most other Digital Banks/Fintechs in 2021, a banner year in the space.
Growth was back for Monzo, all in the UK, almost all of which was organic.
It has reached 5m customers, with about 100,000 new customers joining each month.FT
The renewed confidence stemmed from not only doubling revenues in 2021, but also a 25% increase from new products created in 2020.
Roughly 25 per cent of revenues came from new products launched during the pandemic such as its business and premium accounts.FT
Monzo Premium is a subscription product that costs £15 per month with a 6 month minimum contract.
There were also setbacks for the company in 2021:
- it was announced they were under investigation by the UK’s FCA Regulatory authority in Q3 ’21 for AML violations (subsequently dropped in 2022)
- consequently, they withdrew their U.S. Banking License application in Q4 ‘21 after it became apparent they would not get approved
German-based N26 faced similar scrutiny from the German regulator and consequently had their growth capped at 50,000 new customers per month, well below their potential growth rate.
To piece together the exact picture is a little challenging given that Monzo releases their FY Annual Reports mid-year, but in mid 2021 they had ~5 Million Customers, and by mid 2022 they had ~6 Million Customers (all in the UK), meaning that they probably exited 2021 with 5.5 Million users and an extra $500 Million in the bank from their Q4 ’21 fundraising round.
They also launched their own BNPL (Buy Now, Pay Later) product called Monzo Flex Pay in Q3 ’21, an attempt to further diversify revenue streams.
Customers can also opt to pay in six and 12 instalments, but with these options they pay interest at 19% APR. The bank said it would be offering customers pre-approved credit at the checkout – up to an approved limit of £3,000 – after a “comprehensive affordability assessment”. It will also let people use Flex to pay for something up to 14 days after they buy it.Guardian
2022 – Carnage for Digital Banks, Monzo has Ups & Downs
At the end of 2022, we can see that whatever optimism there was for most Fintechs/Digital Banks at the beginning of the year was erased by the end of it. While the Nasdaq Index itself was down almost 34% in 2022, the average Digital Bank took a hit of roughly 65%. Very few players in both public and private markets were able to buck that trend.
Looking at Monzo’s P&L from their 2022 Annual Report, with accounts stated up into Q1 ’22, we can see that things improved for Monzo’s core business model over the years, adding a lot of stability from the worst of the pandemic.
They have 4 major line items relative to their core business model:
- Net Interest Income earned on the NIM spread between what is paid to depositors and what is earned from lending : + ~50% YoY (Year over Year)
- Net Fee and Commission Income earned through Subscription + Interchange Fees from the various levels of accounts: + ~100% YoY
- Other operating income which came from other banking products on their platform for their user base, a common strategy among Digital Banks: + ~500% YoY
- Expected Credit Losses due to expected delinquencies/defaults from customers who took out loans: + ~350% YoY
On the positive side, the 2X jump in ‘Net Fee and Commission Income’ was notable. Likely, a solid % of revenue comes from Subscription Fees across Premium/Plus Accounts, plus revenue on Business Accounts. It is not just Interchange Revenue.
On the negative side, the ‘Expected Credit Losses’ jumped exponentially as a % of ‘Net interest income,’ putting their business model into the crosshairs for more problems if we see a recession in the UK going into 2023. We may assume, since Monzo launched its ‘Flex Pay’ BNPL product in Q4 ’21, that some percentage of these losses are attributable to BNPL, which was a bloodbath in 2022. Klarna and Affirm were down 85% and 89% respectively.
Overall, we can see that Monzo’s losses improved from 2021 (-£131 Million) to 2022 (- £119 Million) across the whole business model, while revenue nearly doubled. The good news is that auditor dropped their case in mid 2022 and the company enters 2023 in a better position than many of its peers with a relatively well-diversified banking business model.
A significant percentage of their customers (Power Laws) are now using Monzo as their primary bank (Primary Financial Institution), which is probably the best signal of all.
Monzo’s average customer seems to be more valuable to its bottom line with one million customers using Monzo as their “main bank”, whatever that means. Monzo customers are using their cards more and becoming more comfortable with keeping larger deposits at the bank and/or attracting customers with more money.AltFi
They also won at the British Banking Awards for ‘Best British Bank,’ ‘Best Banking App,’ and ‘Best Business Banking Provider’ indicating that customer satisfaction remains high for the challenger brand. These were there first awards, taking the crown from Starling. They exit 2022 on pace to reach 7 Million users sometime in 2023 and generating more in profit per customer.
Monzo Outlook – 2023 and Beyond
With the Challenger Banking business model in the crosshairs going into 2023 and optimism either fading fast or at rock bottom – depending on your perspective – Monzo has a few positives:
- established presence in a developed market (the UK) where they have a banking license and a large enough user base who are loyal to the brand
- a diversified business model that is not over-reliant on Interchange Revenue, arguably the biggest problem for many Digital Banks, especially in the U.S. market
- continued commitment to customer service and good publicity in the media relative to their brand
It seems highly unlikely that Monzo will be muscled out of the market by another competitor. Revolut is neck-and-neck with Monzo in the UK – with Monzo holding the edge – but Revolut’s mission is around the ‘Super App‘ and they are making big international moves heading into 2023. Monzo is intent on protecting its home turf, the only market it operates in.
The potential problems for Monzo going forward stem from their lending business, particularly BNPL. The increased provision for ‘Expected Credit Losses’ in 2022 may have been offset by the big-picture of revenues doubling and losses narrowing, but any sort of ‘risky loan’ portfolio for a Digital Bank will have likely deteriorated significantly in 2H 2022, and is unlikely to have yet found a bottom going into 2023.
Monzo Flex – BNPL Risks
Klarna took a massive private-valuation hit from $45.6 Billion in Q2 ’21 to a $6.7 Billion a year later after announcing roughly $290 Million loss in the first half of 2022 from the U.S. market alone. Klarna’s upside is that they recently launched Spotlight – a video shopping app – and are adding a performance-marketing model to their retail-centric strategy. Thus they are not all-in BNPL, like Affirm, but still heavily exposed.
In response, both companies have tightened lending standards.
Both Affirm and Klarna — which is underpinned by a bank — claim to have stabilized delinquencies by tightening their underwriting standards in the latter half of 2022.American Banker
After what happened to Monzo in 2020, BNPL represents a risk, especially under the initial 2021 terms of ‘pre-approved credit up to £3,000’ (now down to £1,200). For all the upside potential generated by a banking business model that seems to have a good mix of Interest Income, Interchange Revenue, and Subscription revenue, if Credit Losses blow up in early 2023 then it will be a problem for Monzo.
The flip side is that the BNPL market may bottom, inflation may be reigned in due to higher rates, and some significant economic recovery will happen throughout the year.
There are many different models of BNPL, with Afterpay’s original model skewing more towards the traditional ‘Pay in 4’ model where younger customers use it for online purchases (principally) of lower-value goods (ie. $100). Merchants pay the fee, typically 4 – 6% of the purchase, which generally gets branded as a ‘customer acquisition cost.’
When competition started to intensify in later 2020 and 2021 – especially in the US – companies like Klarna and Affirm started lending higher amounts with lower risk standards, and their respective Financing products started to mirror a high-interest loan or credit-card payment. BNPL competition increased exponentially in the UK as well, with both Big Banks and Digital Banks like Monzo entering the fray.
Large UK banks are introducing their own BNPL services to win back younger consumers, with NatWest, HSBC, Monzo and Virgin Money all launching products over the past yearInternational Banker
The difference between Monzo and the Big Banks listed is that these are established banking brands that can absorb large losses on credit portfolios – they take the risk in the interest of market share.
Overall, going into 2023 there are both some very positive factors for Monzo and some underlying risks to their business model. This sounds very typical for a bank, which Monzo is – officially. The IPO rumour mill will likely get restarted for Monzo in 2023, but the ultimate determination will likely depend on market conditions. In the interim, Monzo will push for profitability and continue to innovate as a true challenger bank into 2023 and beyond.
Top 3 – Learn More
The Digital Banking Business Model – 2023 Outlook