What’s behind SoFi’s soaring business model?
SoFi (Social Finance) was started in the post-GFC (Global Financial Crisis) era as a challenger model to the Mega Banks before the concept of challenger banks even existed.
Now a multi-billion dollar public brand, we look at the SoFi Business Model Canvas.
SoFi Business Model
SoFi Strategy – Targeting A Lucrative Niche
HENRYs (High-Earning-Not-Rich-Yet) Millennials were the market that SoFi broke-in with when they launched in 2009. Back then, and to this day, you had to be a ‘Member’ to join SoFi.
“HENRYs are still young—between 25 and 34—and are still moving up the career ladder. They represent the top 20 percent of households in terms of income, earning anywhere between $100,000 and $250,000 a year. Because they earn more than the middle class, HENRYs have more spending power and could afford more expensive purchases.
They initially targeted graduate students at Ivy League Universities from the ‘HENRY’ segment for student loans, and expanded the category of products to include mortgages, personal loans, and other banking products, all the while offering ‘membership-grade’ customer service and better rates than competing entities (the Mega Banks).
“Student loans were interesting: $1.3 trillion market, 65% of business-school students borrow, paying at the time 6.8%-7.9% with a cost of capital of 4.5% as long as you could manage the risk.”
WSJ
The ‘HENRY’ name has now been replaced with HENWS (High Earning Not Well Served) for those earning $100K+, but the concept remains the same.
How does SoFi make money?
The more relationship-based strategy – as opposed to the modern transactional strategy in banking – has propelled SoFi from a company that started up on the West Coast in a Graduate School to publicly-traded company that is now challenging the Wall Street banks.
SoFi Core Revenue Stream – Lending
In other words, the principal way that SoFi makes money is by lending to its customers, who are lower-risk than average U.S. borrowers from a credit-risk perspective. While they are not yet officially a bank, they received the green light to get their national bank charter in Q4 last year, and acquired a Community Bank in Q1 of this year to speed up the process.
Once they officially become a bank, they can then take in customer deposits and loan out against those, rather than relying on 3rd-party underwriters as they do now.
A national bank charter will give SoFi the ability to accept deposits and make loans that use SoFi’s member deposits as opposed to funding its loan offerings as a nonbank, by contracting external underwriters at a premium.
Tech Crunch
As a proxy, the average NIM for U.S. Community Banks in Q2 2020 was 3.27% vs. 2.68% for the U.S Mega Banks, which happen to be the lowest levels in reported history according to the FDIC, largely due to declining interest rates and inflation expectations.
Nonetheless, a 3% NIM starting range is the initial expectation for SoFi once they have their bank charter and are fully-insured and ready to take deposits.
Future Strategy – Revenue Diversification
As we can see from the above ‘Investor Call Deck’ that was released in late 2020 ahead of their Q1 2021 SPAC, Lending accounts for roughly 83% of SoFi’s current revenue as of the end of 2020.
Galileo Business Model
Another 17% comes from the Tech Platform Galileo (acquired by SoFi for $1.2 Billion in Q2 2020), which is the underlying infrastructure that powers not only SoFi, but also other challenger banks like Chime and trading platforms like Robinhood.
As of Q1 ’21, Galileo powered more than 70M Fintech accounts.
While we don’t know the exact mechanics of the Galileo business model (they have Galileo Instant and Galileo Pro), it is a hybrid between a payment-processing model (based on interchange fees) and SAAS model (based around features).
With Galileo’s principal competitor – Marqeta – scheduled to go public in June 2021, we can learn a lot about the mechanics of this type of Fintech Infrastructure business model between interchange fees and API-based SAAS revenue streams via their S-1.
Financial Services Business Model
We can see that SoFi is planning to evolve its business model over the next several years to capture much more revenue from Financial Services, presumably based on its ability to cross-sell new products to its Member base once it can fully operate as a bank. None of this should be surprising, as this has always been the vision communicated by SoFi executives since inception.
“There is going to be a seismic redistribution of market cap in the banking world,” he says. “They won’t see it coming until it’s done.” SoFi CEO
WSJ
The strength of this model is relative to potential ARPU upside vs. limiting CAC, a big cost for the majority of Fintechs.
Community-Centric or Commercial Partner Strategy?
What makes SoFi unique from most other challenger banks is the premise of Membership, which is much more of a community-centric strategy as opposed to a commercial-partner strategy seen across the banking world, from both disruptors and incumbents.
Individuals must be accepted in order to become SoFi Members. The segmentation, from SoFi’s perspective, allows them to identify higher-income individuals (HENWS) who present a lower credit risk. SoFi offers them much more value than competing banks and challengers from a lending perspective.
This type of exclusivity is an atypical strategy in the current environment, but the goal is to create a more social brand around finance (hence the name ‘Social Finance’).
As seen above, beyond Community features like a Facebook Group, they offer Career Coaching, Estate Planning, and other services that in the in long run contribute to both the ‘financial health’ of the consumer and the strength of their balance sheet.
Remembering that SoFi started out of the embers of the 2008 Subprime Mortgage meltdown when NINJA (No Income No Job) loans were in vogue, SoFi wants to make sure that it limits any related risks to its customers suffering from unemployment or other adversity.
SoFi’s Member Focus
Obviously SoFi wants to make money and compete with the Wall Street Mega Banks like all other challenger banks. They just have a very unique and compelling way of doing that, which is to limit credit risk and lower Customer Acquisitions Cost (CAC) by cross-selling multiple products to its Membership base. The Membership benefits directly serve this strategy.
Leveraging the financial services productivity loop (“FSPL”) strategy where building TRUST and a “RELATIONSHIP” in the 1st product drives success in the next, results in Highest LTV & Lowest CAC resulting in our competitive advantage. Best unit economics from lower CAC, lower cost from vertical integration win
SoFi Investor Call Deck 2021
Fundraising and Valuation
SoFi launched a SPAC (Special Purpose Acquisition Company) with Chamath in Q1 2021 under the ticker IPOE.
The SPAC merger is set to officially complete next week, when SoFi will begin trading on the Nasdaq under the SOFI ticker.
Based on current trading, the company is valued ~$17 Billion. They have raised about $2.5 Billion collectively leading up to the SPAC, while the SPAC itself provided the company with about $2.4 Billion in cash, leaving the company well-capitalized for future growth.
SoFi Business Model Canvas
A business model is defined as:
“the rationale of how an organization creates, delivers and captures value.”
Alex Osterwalder et al invented the Business Model Canvas to help individuals and organizations conceptualize how to analyze, create, and develop business models.
SoFi Value Proposition
Membership-based Challenger Bank offering Members a suite of loan products and other benefits:
- Student Loans, Mortgages, Personal Loans, etc. at better rates than competing financial institutions
- Member Benefits – exclusive community groups, career counseling, estate planning, etc
SoFi Business Model Analytics
Playing the long-game of LTV (Lifetime Value), which is a function of customer loyalty and repeat revenue-generation, is the best way to win any hyper-competitive, consumer-centric market.
The acquisition of Galileo in Q2 2020 prevents SoFi from having to form a commercial partnership with the one company that ends up becoming their biggest asset going forward as they take on the banks.
The technology platform behind SoFi, along with all the corresponding data produced, help the company achieve ‘vertical integration’ and scale-up the business across multiple different product portfolios.
The company also has commercial partners to power specific products. Examples include education platform Coursera for a course on the ‘Fundamentals of Personal Finance‘ and market-data platform Xignite to power the ‘SoFi Invest’ module, among other partnerships.
The Launch of SoFi Plus
In Q4 ’22, SoFi launched SoFi Plus, a service that doesn’t cost users any additional fees compared to their traditional membership program but requires them to connect their Direct Deposits to SoFi directly. The benefits are multi-fold.
In many ways, as a banking customer in the U.S. (the only place SoFi is available as of the end of 2022), many of the benefits seem almost beyond belief compared to the competition:
- Up to 3.5% APY (Annual Percent Yield) paid to savers directly as a % of their deposits – this compares to 1.5 – 2.0% offered by most other banks in the U.S.
- 3% Cash Back on Credit Card purchases
- 2X Rewards points
- Plus all the additional benefits of Membership SoFi offers
So what’s the catch?
This is clearly an aggressive Customer Acquisition strategy by SoFi, in line with the current shifts in their business model towards more FPSL (financial services productivity loop) and less loans.
In their latest financial report (Q3 ’22), SoFi claims to have reached the ‘inflection point’ for their Financial Services products.
They are clearly losing money at 3.5% APY and 3% Cash Back on Credit Card purchases from a NIM perspective, but if they can make it up through Invest, Money, Relay (Insights), and other financial services products then the strategy makes sense.
In terms of revenue breakdown from the latest quarter (Q3 ’22):
- Lending ‘Adjusted Net Revenue’ came in at $297M (69%)
- Tech Platform ‘Net Revenue’ came in at $85M (20%)
- Financial Services ‘Net Revenue’ came in at $49M (11%)
Thus we can see the shift in motion towards SoFi’s goal of making Financial Services 32% of the revenue mix by 2025, up from 2% in early 2021.
Nearing the end of 2022, SoFi had 424,000 Members, up 61% YoY for its core banking service. The tech platform Galileo reach 124 Million accounts, up 40% YoY.
On a GAAP basis, however, they continue to lose money, losing about $75M in their most recent quarter. The company’s stock (Ticker: SoFi) was down more than 70% in 2022 in what was a tough year for all Challenger/Digital Banks.
But they did receive conditional approval on their U.S. Banking Charter in 2022 (ex Crypto) and have many positive developments going into 2023.
SoFi Outlook – 2023 and Beyond
Seeing the SoFi equity price go from about $15 per share to $4 per share over the last 12 months couldn’t have been pleasant for those invested in the company. It is hard to say if the 2022 performance was due to macro factors (as almost all major Fintechs were down >50%) that SoFi can’t control (interest rates, inflation, etc.) or micro factors that they can control.
Nevertheless, it doesn’t seem like they have strayed from their core strategy in any way over the last 12 – 18 months, and the addition of a U.S. Banking Charter should come with multiple benefits for their business model going forward.
As a ‘Members Bank’ that focuses on credit quality, SoFi (425K+ Members) is not as exposed to the same factors as other US-based Digital Banks who either:
- a) are heavily dependent on Interchange Revenue like Chime (12 Million+ US Users)
- b) are heavily exposed to risky credit products (ie. BNPL) like Affirm (14 Million+ Active US Consumers)
With the launch of SoFi Plus and all the additional benefits it offers, we expect to see SoFi’s Member #s jump in Q4 ’22 and beyond. But they will never be at the scale – in all likelihood – of Chime, Affirm, or other players.
Ironically, Chime is one such company powered by SoFi-owned Galileo. As much as they compete in some ways, they are also partners in others. Robinhood is also powered by Galileo.
In relation to Affirm, SoFi just announced they are adding BNPL capabilities to the Galileo platform. This means that anyone who uses Galileo in Fintech can offer BNPL. While a risky market to enter in many ways (not for SoFi/Galileo directly), it shows that SoFi is not constrained by simply competing head-to-head against other Digital Banks.
Galileo, Technisys, and Next-Gen Banking
And this is the advantage that SoFi specifically has going forward into 2023 and beyond. With Galileo in the mix, they maintain a tremendous upside irrespective of the other pressures in the market. The value of this technology is hard to quantify in real terms (SoFi paid $1.2 Billion for Galileo in 2020) as are most technologies at an early stage.
The future market for an advanced back-end banking platform is obviously exponential. With Chime, Robinhood, and others on Galileo now, we can imagine that other innovative banking players will join in the future. Furthermore, SoFi acquired Argentina-based Technisys for $1.1 Billion in a move that further powers the Galileo strategy and opens new markets.
In the US, the firm counts Rellevate and Tab Bank as clients, while in LatAm, it powers Brazil’s first bank with completely digital checking accounts, Banco Original
Tearsheet
Thus, while we don’t know exactly what ‘next-gen banking’ will look like from a platform perspective, we know it involves concepts like embedded finance and the application of machine learnings/artificial intelligence to power the banking experience. We can imagine that with Galileo and now Technisys under SoFi’s control, the company has a pretty good view about where the market is going.
There will be competition, undoubtedly, in this space by the likes of Marqeta, Stripe, and others. That means after a tough 2022, 2023 might not get much easier coming out of the gates. But in the global scheme of Digital Banks, SoFi has unique attributes and advantages that no other competitor has. Let’s see how 2023 evolves across their product and technology portfolio.