Zopa launches a new lending model

Context

It might be thought that innovation in business models was left behind in the dot-com era, but still fledgling businesses are launching new online services. Zopa is an interesting example launched in March 2005.

Zopa is an online service which enables borrowers and lenders to bypass the big high street banks. It is an example of a consumer-to-consumer exchange intermediary. It illustrates the challenges and opportunities of launching a new business online, especially a business with a new business model.

Zopa stands for 'Zone of Possible Agreement' which is a term from business theory. It refers to the overlap between one person's bottom line (the lowest they're prepared to receive for something they are offering) and another person's top line (the most they're prepared to pay for something). In practice, this approach underpins negotiations about the majority types of products and services.

The business model

The exchange provides a matching facility between people who want to borrow and people who want to lend. Significantly, each lender's money is parcelled out between at least 50 borrowers. Zopa revenue is based on charging borrowers 1 per cent of their loan as a fee, and from commission on any repayment protection insurance that the borrower selects. At the time of writing, Zopa estimates it needs to gain just a 0.2 per cent share of the UK loan market to break even, which it could achieve within 18 months of launch.

The main benefit for borrowers is that they can borrow relatively cheaply over shorter periods for small amounts. This is the reverse of banks, where if you borrow more and for longer it gets cheaper. The service will also appeal to borrowers who have difficulty gaining credit ratings from traditional financial services providers.

For lenders, higher returns are possible than through traditional savings accounts if there are no bad debts. These are in the range of 20 to 30% higher than putting money in a deposit account, but of course, there is the risk of bad debt. Lenders choose the minimum interest rate that they are prepared to accept after bad debt has been taken into account for different markets within Zopa. Borrowers are placed in different risk categories with different interest rates according to their credit histories (using the same Equifax-based credit ratings as used by the banks) and lenders can decide which balance of risk against return they require.

Borrowers who fail to pay are pursued through the same mechanism as banks use and also get a black mark against their credit histories. But for the lender, their investment is not protected by any compensation scheme, unless they have been defrauded.

The Financial Times reported that banks don't currently see Zopa as a threat to their high street business. One financial analyst said Zopa was 'one of these things that could catch on but probably won't'.

Zopa does not have a contact centre. According to its web site, enquiries to Zopa are restricted to e-mail in order to keep its costs down. However, there is a service promise of answering e-mails within 3 hours during working hours.

Although the service was launched initially in the UK in 2005, Financial Times (2005) reported that Zopa has 20 countries where people want to set up franchises. These include the US, where Zopa has a team trying to develop the business through the regulatory hurdles. Other countries include China, New Zealand, India and South American countries.

About the founders

The three founders of Zopa are chief executive Richard Duvall, chief financial officer James Alexander and David Nicholson. All were involved with Egg, with Richard Duvall creating the online bank for Prudential in 1998. Mr Alexander had been strategy director at Egg after joining in 2000, and previously had written the business plan for Smile, another online bank owned by the Co-operative. The founders were also joined by Sarah Matthews, who was Egg's brand development director.

Target market

The idea for the business was developed from market research that showed there was a potential market of 'freeformers' to be tapped.

Freeformers are typically not in standard employment, rather they are self-employed or complete work that is project-based or freelance. Examples include consultants and entrepreneurs. Consequently, their incomes and lifestyles may be irregular, although they may still be assessed as creditworthy. According to James Alexander, 'they're people who are not understood by banks, which value stability in people's lives and income over everything else'. The Institute of Directors (IOD) (2005) reported that the research showed that freeformers had 'much less of a spending model of money and much more of an asset model'.

Surprisingly, the research indicated a large number of freeformers. New Media Age reported Duvall as estimating that in the UK there may be around 6 million freeformers (of a population of around 60 million). Duvall is quoted as saying: 'it's a group that's growing really quickly. I think that in 10 or 15 years time most people will work this way. It's happening right across the developing world. We've been doing some research in the US and we think there are some 30 or 40 million people there with these attitudes and behaviours'.

Some of the directors see themselves as freeformers, they have multiple interests and do not only work for Zopa; James Alexander works for one day a week in a charity and Sarah Matthews works just 3 days a week for Zopa. You can see example personas of typical borrowers and lenders on the web site: www.zopa.com/ZopaWeb/ public/how/zopamembers.shtml.

From reviewing the customer base, lenders and borrowers are often united by a desire to distance themselves from conventional institutions. James Alexander says: 'I spend a lot of time talking to members and have found enormous goodwill towards the idea, which is really like lending to family members or within a community'. But he also says that some of the lenders are simply entrepreneurs who have the funds, understand portfolio diversification and risk and are lending on Zopa alongside other investments.

Business status

The Financial Times (2005) reported that Zopa had just 300 members at launch, but within 4 months it had 26,000 members. According to James Alexander, around 35 per cent are lenders, who between them have £3m of capital waiting to be distributed. The company has not, to date, revealed how much has been lent, but average loans have been between £2,000 and £5,000. Moneyfacts.co.uk isn't showing any current accounts with more than 5 per cent interest, but Zopa is a riskier product, so you'd expect better rates. Unlike a deposit account, it's not covered by any compensation schemes. ^

Marketing communications

The launch of Zopa has been quite different from Egg and other dot-coms at the turn of the millennium. Many companies at that time invested large amounts in offline media such as TV and print to rapidly grow awareness and to explain their proposition to customers.

Instead Zopa has followed a different communications strategy, which has relied on word-of-mouth and PR with some online marketing activities where the cost of customer acquisition can be controlled. The launch of such a model and the history of its founders, makes it relatively easy to have major pieces about the item in relevant newspapers and magazines such as the Guardian, the Financial Times, the Economist and the Institute of Directors house magazine, which its target audience may read. Around launch, IOD (2005) reports that Duvall's PR agency, Sputnik, achieved 200 million opportunities for the new company to be read about. Of course, not all coverage is favourable, many of the articles explored the risk of lending and the viability of the start-up. However, others have pointed out that the rates for the best-rated 'A category' borrowers are better than any commercial loan offered by a bank and for lenders, rates are better than any savings account. The main online marketing activities that Zopa uses are search engine marketing and affiliate marketing.

Funding

Zopa initially received funding from two private equity groups, Munich-based Wellington Partners and Benchmark Capital of the US. Although the model was unique within financial services, its appeal was increased by the well-publicised success of other peer-to-peer Internet services such as Betfair, the gambling web site, and eBay, the auction site.

Sources: Financial Times (2005), New Media Age (2005), Institute of Directors (2005), Zopa web site (www.zopa.com) and blog (http://blog.zopa.com).

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