Originally published 29 Sept 2021

This is Sufficient Balance One — a five-part content series about the opportunities in African Fintech. Brought to you by DFS Lab and The Subtext. Originally published as an email series in 2019, this first chapter lays the foundation for everything that will come after; read it to learn how to think about the market and follow up with our more recent Sufficient Balance Two series.
Stephen Deng, Partner, DFS Lab & Osarumen Osamuyi, Author, The Subtext

Tim Wu, in The Master Switch: “[w]ithout exception, the brave new technologies of the twentieth century … eventually evolved into privately controlled industrial behemoths…”

M-Pesa launched in early 2007, and grew at lightning speed to over one million users by the end of the year. Even so, few predicted the behemoth it would become — dominating Kenya’s economy, and becoming ubiquitous to the point of invisibility with nearly 80% of adults.

The combination of USSD-based mobile accounts that worked on every phone and cash-in/cash-out agents in nearly every neighborhood and village proved to be powerful infrastructure on which to build new product offerings. And a similar story — albeit with a few years delay — has played out in many African markets, though not all.

Nigeria, South Africa, and a few others have not seen mobile money flourish as it has elsewhere. Nevertheless, there have been significant fintech developments in these markets, driven by the shared trend of mobile phone adoption and digital connectivity. In both Nigeria and South Africa, these new products and services have been built directly on bank and card infrastructure rather than mobile money, again highlighting how entrenched invested infrastructure can be.

Fintech 1.0: Single-purpose and Corrective Tissue

The first innovation built on top of the mobile money infrastructure was the pay-as-you-go (PAYG) solar model, pioneered in 2010 by Jessie Moore and Nick Hughes’ M-Kopa. (Nick lead the team that created M-Pesa at Safaricom).

Nearly half of African households have no electricity and while home solar kits have existed for a long time, few households can afford the full upfront cost. M-Kopa helps solve this problem by wiring the kit with a mobile SIM which lets them shut off the device at will. They then give out kits for 10–20% of their face value and let consumers pay them off over time in daily or weekly micro-installments via mobile money. If they don’t pay, their electricity is shut off until they do. M-Kopa was more a financing innovation than an energy innovation, and the PAYG model would not function if field staff had to go collect these small value payments in person — it would be way too expensive.

As one of the first sectors built on top of mobile money rails, PAYG solar will have reached over 10 million people by early 2020 and generated a billion dollars of cumulative revenue across 100+ companies. While it looks nothing like e-commerce applications in the United States, PAYG proved that mobile money could be the foundation — the ‘infrastructure’ — on which other scalable applications could thrive.

Recommended Reading: A Decade in, Why the Pay-As-You-Go Solar Sector is Maturing and Brightening

While most African countries have at least one credit reference bureau, only 5–15% of the population are usually listed because most people don’t have the regular utility bills, bank accounts, credit cards, mortgages, or any of the other formal financial relationships that classic credit bureaus track to create their databases. With its ledger of “digital financial footprints” mobile money created a source of consistent transaction data for the 80–90% majority who are not in traditional bureaus. It made sense that the next sector to take off was that of thin-file digital lending.

Like PAYG solar, the digital lending sector thrived as a single-purpose product that leveraged mobile money as its payments rail and data source. An uptick of smartphones among middle and upper class citizens provided an opportunity to be able to cost-effectively gather data on potential customers and subsequently provide loans via mobile money accounts.

The model has proven to be extremely popular, with 6 million Kenyans having taken at least one digital loan. Market leaders Tala and Branch, each raised more than $100 million within months of each other in 2019. Given the low barriers to entry (a front end app developer with basic machine learning skills could launch an app in months), this has led to an explosion of non-bank, unsecured lenders in markets with a lax regulatory environment. Recent estimates have counted 200 different app-based lending apps in Kenya alone. Interest rates on these products are typically between 200–500% APR, but some of them run over 1000%. Tala and others often tout their positive “financial inclusion” impact but are rarely straightforward about their terms in public statements.

Regulators and government officials have pushed back. Even Google has banned some of these apps. There is a real concern about loan stacking and sports betting, where users take out loan after loan to place bets and to keep up with payments on previous loans. Fraud is also becoming increasingly sophisticated with some estimates that digital lenders in Kenya deal with 1.9 million fraudulent loan applications a year — many of which are linked to sophisticated crime syndicates elsewhere in the world.

The future of these lending companies is far from certain, but their popularity despite eye-wateringly high interest rates highlights the need for accessible credit. And the market is starting to mature and produce more sophisticated models. Pezesha (a DFS Lab company) is building a credit scoring marketplace that functions more like a traditional reference bureau in that it provides scores to banks and other financial institutions to make loan decisions rather than always lending on their own. In this model, financial institutions usually have multiple touch points and other sources of data on the client which reduces fraud and allows for lower interest rates.

Recommended Reading: Great Expectations: Fintech and the Poor

In addition to the relatively narrow, single purpose applications like PAYG and digital lending that sprouted on mobile money infrastructure, there have also been fintech 1.0 companies that largely served as “corrective tissue” to the poorly designed payment services and product architecture of banks and mobile operators. These played out not only in the mobile money sector but also bank-based markets like Nigeria.

Newly minted unicorn Interswitch is one example which corrects the non API-based systems that banks built and layers on top payment gateways, switches, POS systems, and various other solutions that reduce friction in accessing legacy infrastructure. Cellulant and Beyonic and others have a similar model where they integrate to mobile money providers and offer a cleaner, easier to manage API based service that allows developers and other fintechs to use these rails more effectively.

All encompassing, these models represent fintech 1.0 — the single-purpose or corrective tissue offerings built on top of mobile money and traditional banks. So, what comes next?

The Innovator’s Dilemma and Platformization

Even with the evergreen claim in fintech that “banks are being disrupted” and an especially sclerotic and slow-moving African banking sector, it doesn’t seem banks in sub-Saharan Africa are going anywhere. In fact, banks in Africa are doing very well and nearly twice as profitable as the rest of the world due to being a heavily protected sector with limited competition held at bay by regulators. For example, nearly every regulator has required mobile money operators to partner with banks who serve as escrow accounts holders for the funds mobile money accounts. Mobile operators have proven a bit quicker to innovate and have been effective at using their large base of mobile phone customers to drive mobile money adoption, but have been similarly sluggish when it comes to moving beyond these initial successes and developing their models further.

Recommended Reading: Embracing payments as a platform for the future of mobile money

As these incumbents have been challenged by new entrants, they have fought back with “internal innovation” efforts to try and adapt and modernize their offerings but most of these initiatives are likely to fail. Safaricom’s Alpha incubator which sought to encourage fintech collaborations has largely been unsuccessful. Equity Bank’s fintech division, Finserve, looks like it’ll meet a similar fate as executives leave and lofty short-term revenue targets fall short. There are efforts from some incumbents to open up their ecosystems and directly diversify their offerings such as MTN’s MoMo API. However, these efforts may be a little too late. Most lack the clarity of vision and conviction necessary to transition from a narrow set of profitable but limited use cases to a more open system allowing innovative third parties to develop new offerings, but potentially cannibalize existing revenue streams. This is the classic Innovator’s Dilemma.

Even the early fintech 1.0 models now find themselves becoming infrastructure. For example, Interswitch is infrastructure for platforms like Flutterwave and Paystack, and they in turn, for new players like Piggyvest.

A fintech 2.0 ecosystem is quickly emerging where banks, mobile network operators, and even previous generation fintechs sit squarely as utility-like invested infrastructure. This new ecosystem is being built by multi-vertical platform companies:

Each of these companies have a fintech element within their platform allowing it to function as the driver of a variety of different economic activities. A few examples:

Recommended Reading: Transsion’s Trojan Horses

These players don’t need to pivot to a platform strategy because platformization was the strategy from day one. The growth-by-layering strategy is much easier with these digital native services who don’t have the legacy invested infrastructure of banking or mobile platforms to overcome. The battle lines in fintech 2.0 are defined by the unique customer acquisition model each player is trying to exploit. Opera’s OPay and Transsion’s PalmPay are each using the power of the default, taking a page out of Microsoft’s Internet Explorer playbook — Transsion, by installing the app at the device factory, and Opera, acquiring users through its default Opera browser. SafeBoda will learn from its investor Gojek and use high-frequency, low-to-negative-margin services like ridesharing to build repeat usage and trust. KaiOS wants to build an iPhone moment for itself in Africa through high-quality feature phones loaded with its built-for-purpose operating system and open app store.

However, not all platforms are built the same — especially in the context of emerging markets — and in the next chapter, we’ll explore why.