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Little drops make the mighty ocean is an apt adage that captures the significance of individual units that make up the whole. Unit-level analysis is a great place to start for all digital lending players vying for positive economics in their business. Minor tweaks at the granular level, although they could appear negligible at first, when done continuously and consistently lead to enormous outcomes — even mountains can be levelled by the slender force of persistence.
So, it’s recommended to break down your lending business into measurable parts to do two things: analyse performance at the unit level and identify areas for improvement. Small fundamental changes such as strengthening weak links in your lending funnel are bound to have a knock-on effect on the entire business’ cost-revenue dynamics. After all, micro is what shapes the macro.
What exactly is unit economics and why is it important?
The building blocks of any business are always the same; costs and revenue. Unit economics describes a business model's revenue and costs in relation to an individual unit.
Theoretically, unit economics is the ratio of Customer Lifetime Value (Average value of a loan x Number of loans per customer) to Customer Acquisition Costs.
However, in the lending business, this metric is rather restrictive as costs go beyond the stage of customer acquisition and are incurred at every level of the lending funnel. Cost of funds, underwriting cost, servicing cost, compliance cost, and collections cost are some other costs that lenders incur at various stages of loan origination. It is important that each of these costs are accounted for in unit economic analyses to draw an accurate picture.
The below illustration depicts the various stages of loan origination.
You crack the code of servicing loans for one customer profitably and you have solved the fundamental problem of breaking even. Unit economics strips it all down to answer pertinent questions such as:
Are the expenses incurred with regard to, say, marketing worth every dime?
Are there any costs that can be reduced at any stage in the lending funnel?
Can the lending funnel be optimised in any specific way?
Can bundling financial products a certain way improve profitability?
Is the lending business expected to generate revenue or only act as a funnel-filler for other revenue streams?
For instance, a digital lender spends, on average, Rs. 1000 per customer as part of marketing and advertising. Let’s assume that an ad attracts 100 customers to the loan application page but only 10 of them sustain until the bottom tip of the lending funnel to avail loans. The rest 90 may have dropped off due to a variety of reasons ranging from sheer disinterest to complex sign-up process to ineligibility.
In this case, the conversion rate (lead-to-disbursal ratio) is 10%. For you to break even, the value you generate from one customer must cover the total cost of servicing loans to that one customer plus advertising and funnelling cost for 10 customers. So, you may have to charge a rate of interest that captures the value you aim to achieve from this one acquired customer.
But then there’s the challenge of remaining competitive in an otherwise crowded industry. Therefore, it becomes imperative for lending institutions to get inventive in finding ways to achieve profitability. Here are a few ways that could help you break even or scale your profits.
Save a penny, earn a penny
Strategizing cost efficiency is a good way to improve margins. Lending institutions must work into their fiber the idea that ‘no cost is too small to worry about’. Every penny counts in the lending business, for it’s an industry where a good number of lenders are struggling to break even while others operate on tight margins.
Going digital is one sure shot way of achieving cost effectiveness. According to data from consultancy firm Oliver Wyman, a traditional bank needs $150 to onboard a new individual customer while a fintech requires only $30, thanks to efficient digital onboarding processes. This is just one example. Cost efficiencies cumulate along the lending funnel with digitalization. McKinsey research suggests that a bank with a balance sheet of $250 billion could capture as much as $230 million in annual profit, of which just over half derives from cost efficiencies such as less processing time and lower cost of risk enabled by digitalization.
Another potent area with scope for strategizing spends is marketing. One cost-effective marketing strategy for financial institutions with limited marketing budgets is to advertise locally within the targeted geography. Strategic local tie-ups and identifying community hotspots would help get the word out effectively. If your focus is more on industry-specific businesses, build interfaces with targeted business ecosystems either through web-based marketing or through business consortiums.
No matter what your budget is, thresholds exist even in marketing, especially in a highly competitive industry such as financial services. Everybody is running ads, and customers have a deluge of options to choose from. So, then as a lender, what do you do? Well, if the mountain will not come to Muhammad, then Muhammad must go to the mountain. Sell your loans at the point of sale for goods and services.
Embedded credit lines and Buy Now Pay Later are popular customer choices and a more assured means to disburse loans. And embedded credit also results in access to larger borrower pools along with repeat purchases as well as upsell and cross-sell capabilities.
Run a taut ship
If you want to raise margins, it is extremely important that you drive efficiency of your loan funnel through continuous optimization using historical and real-time observations with conversion-rate analyses.
The first step to optimizing the lending funnel is to identify the steps an application has to move through to become a loan, and at which steps applications tend to “fall out” of the funnel. Minor tweaks such as reducing the number of steps, altering the way you seek information, or prioritizing the information you seek can significantly impact approval rates and drop-offs.
Create new value with bells and whistles
Call on the cousins of selling — upselling and cross-selling — to boost your revenue. Upselling is getting customers to upgrade to a premium product (buy a cow from me, and I’ll offer you a better one for 50 bucks more) while cross-selling is getting customers to purchase complementary products (buy a cow from me, and I’ll throw in a bundle of hay for 5 bucks). Upselling and cross-selling aren’t merely ways to grow your business, they are also effective means to build solid customer relationships.
If you package your loan offerings with non-essential products, hoping to cross-sell, it may fall flat. Today’s online consumers are smart enough to see through such marketing plans in disguise. Therefore, it’s important to create real value for consumers through attractive enhancements rather than add hollow embellishments to your offerings.
Along with carefully bundling financial products, it’s also important to determine who to sell it to. Employing your resources to upsell and cross-sell to every Tom, Dick, and Harry may not be the most efficient.
A targeted strategy such as one guided by Pareto principle — 80% of profits come from 20% of your customers — will be a more cost-effective approach.
Cast your net wide
It is important to reach out to a larger borrower pool to reap cost advantages that come from operating at scale. For instance, women face greater credit constraints than men although the repayment history of women borrowers is far more satisfactory. This is mainly because women lack credit history. One strategic way to grow your loan portfolio would be leveraging alternate data to reach out to new-to-credit women borrowers. This is just one example. The underserved population, especially in tier II and tier III cities offer a market ripe for penetration.
Not all subprime mortgages end in crises. Robust, contextualized risk assessment models can help strategic expansion into new territories and customer segments.
Hold on to your existing customer base
Customer retention is important as it increases your customers' lifetime value and boosts your revenue. Selling a new loan to an existing customer tends to be easier and cheaper than selling it to a new customer, as you already have an established relationship with the customer. There is evidence to prove that improving your retention rate by 5% can have a 25-95% impact on your profits, according to Harvard Business Review.
How is FinBox solving for digital lending unit economics
Lending is complex - we attempt to make it just a bit less uncertain than it has to be.
We secure cost advantages for our partners by managing the entire loan funnel using AI/ML-driven technology. We offer lenders an end-to-end technology stack that automates processes, intelligently optimizes loan funnels, and empowers business strategies with advanced analytics.
Whether you want to embed credit or originate loans, you need to build workflows, negotiate contracts, get approvals and integrate multiple partners. FinBox brings it all together in the form of a drop-in widget. We innovate for the end customer by providing in-context tailor-made financial services at the point of demand creation.
FinBox models have been benchmarked on more than 16 million customers across India. Our proprietary data intelligence products DeviceConnect and BankConnect help underwrite new-to-credit customers with remarkable accuracy. We equip our partners with all the gear to expand their loan portfolios.
We partner with a large variety of lenders, covering different loan products and demographics. This lets us innovate on loan products and maximise coverage. Our machine learning models have been trained on billions of data points and bring its benefits to each partner we work with. We ensure higher approval rates even for new-to-credit customers helping lenders operate at scale.