Unravelling the Economic Model for Digital Lending
An introductory guide for lenders
Your Lending Model for the Digital Age
Lenders have two objectives at the heart of their business:
• To optimise their economic model
• To monitor and improve customer outcomes
Both must be kept in balance, as each cannot happen without the other. Focusing on one at the expense of the other will create an existential threat from either regulatory breaches or financial failure.
The economics of lending are simple.
The lifetime revenue of a customer must be larger than the cost of acquiring them and their fraud and credit risk.
While this statement may appear overly simplistic, it is the foundation of every lending business, and must always be central to every economic model. The three pillars of customer value, acquisition efficiency and commercial risk must be fully understood in order to better optimise the economic model.
Good customer outcomes are primary.
All lending must be responsible, affordable, sustainable, and suitable for customers who are not vulnerable.
A statement that few would disagree with, but lenders’ approaches to each of the three pillars will define customer outcomes, positive or negative.
Factors that affect the optimisation of customer value:
- Quantification of long-term customer value
- Understanding how individual products affect customer value
- Understanding multiple product usage
How to ensure good customer outcomes
- Fully understand product features and their impact(s) on customer outcomes
- Understand how products can be tailored to specific customer needs
Key questions for lenders
- Do you understand customer value at an individual level?
- Do you quantify it?
- Does any element of customer value creation compromise customer outcomes?
- Do different customers get different products based on individual circumstances?
Good Looks Like:
- Predicted customer revenues within acquisition funnel prior to decisions
- Continual refinement of customer value predictions
- Tailoring products to meet customers’ specific needs
Bad Looks Like:
- Considering credit risk and customer value the same thing
- Optimising product revenues through continual cycles of lending
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Orchestrating personalised journeys is key to a responsible lending model
Influence Of The FCA On Lending
The last five years of FCA oversight provide many reminders of both risks. An over-optimised economic model is at odds with good customer outcomes. Examples of this are abundant. Unarranged overdrafts, perpetually high credit card balances, treatment of loan guarantors, and payday rollovers are just some examples. Equally, there are many organisations that have delivered regulatory change to create better customer outcomes, only to find there is no sustainable economic model. Wonga and Brighthouse are two headline examples. More will follow.
Onboarding is the critical customer journey, requiring balance between the economic model and customer outcomes. Decisions taken during this typically short engagement with prospective customers define a lenders’ future. It decides the commercial value of the customers being recruited, and the regulatory risk from the outcomes they are likely to experience.
The Acquisition Journey
New customer acquisition is a primary driver of business growth, an essential part of every economic model. It is best considered using the three elements of the funnel concept;
- Who is entering the acquisition funnel?
- How are they converting through the process?
- Who is getting through the process and being onboarded?
Effective optimisation of customer acquisition focuses on:
- Lifetime value of converted customer by channel
- Conversion performance by segmented customer cohorts
- Individual customer acquisition cost by segmented customer cohort
- Effective assessment of net customer value
Effective customer outcomes rely on:
- Fully assessing customer circumstances for vulnerability, affordability, sustainability and suitability
- Predictive assessment of outcomes
Key questions for lenders
- Do you trade off making applications easy for customers against getting deep customer insight?
- Do you have different journeys for different customer cohorts?
- Do you understand and optimise individual customers’ application experience?
- Do you understand the performance of individual acquisition channels?
- Do you assess applicant quality beyond credit risk?
- Do you understand individual customer acquisition cost?
- Do you optimise how you use third party data services?
- Is every marginal accept consistent with understanding potential customer outcomes?
- Does any element of customer value creation compromise customer outcomes?
- Do different customers get different products based on individual circumstances?
Good Looks Like:
- Predicting individual customer revenue, bad debt provision and acquisition cost early in the acquisition journey
- Ongoing journey optimisation by multiple cohort
- Ongoing channel optimisation based on predicted customer value
- Marginal accepts defined by depth of understanding, not lack of understanding
- Tailoring products to meet customers’ specific needs
Bad Looks Like:
Commercial Risk
Credit and fraud risks have been central to lenders for many years, and continues to see strong innovation in digital lending, particularly around deployment of machine learning and AI to accelerate model refinement.
Find the ‘point of balance’ in lending. Discover our optimised lending model
Book a call with PrinSIX CEO, Julian Graham-Rack to discuss how to achieve the best balance between commercial reward and risk. Previously the CEO of a UK lending provider, he is a recognised subject-matter expert on digital lending optimization.
