Why peer-to-peer factoring tends to failGo to the news page
Peer-to-peer (or P2P) platforms have become extremely popular in the financial industry. If you search on Google for peer-to-peer platforms, the majority of the results link to lending platforms.
The main reason why P2P is so popular, is because it brings supply and demand together. Investors can lend money directly to consumers or businesses.
Despite the rise of these decentralised platforms in the credit industry, it’s curious to see that peer-to-peer platforms have not yet succeeded to take over the factoring business – despite several attempts. I know, because I’ve studied a lot of them before starting Factris.
There are three reasons why P2P platforms in factoring fail.
1. Little or no margin in the value chain
Peer-to-peer platform can only exist if they get a financial reward for bringing supply and demand together. In practice, it turns out that margins in factoring are so competitive that they can’t support an additional layer – even if that layer makes it easier for supply and demand to meet. There’s simply not enough margin to split with everyone.
Recently we received information on a platform in the P2P space trying to scale with a negative gross margin! The customer lifetime value was negative having high front end cost with the customer retention quite low, often resulting in a customer completing the boarding process only to factor a few invoices to meet an immediate need and then leave.
Often customer churn has to do with the high cost associated with P2P lending. Because of the high-perceived risk, investors in these platforms ask for 10 to 15 percent per annum rates making the overall financing cost very expensive for the customers after adding platform fees. Sometimes lending platforms with larger volumes can bring in institutional money to lower the blended weighted average cost of capital, but still capital cost are rarely less 10% per annum.
Most P2P platforms spend a lot of money on digital marketing to attract a large amount of customer interest only to convert less than 10% of the total inquiries. This “shotgun” approach leads to more than 90% of applicants being rejected and is much more expensive than working through the traditional broker networks or direct sales. The remaining prospects who do successfully become customers, very often do not provide a return on investment as they solve an immediate cashflow problem with expensive financing, then leave after factoring one or two invoices.
The marketing spend is normally the largest part of customer acquisition cost, but let us not forget that this cost is in addition to the cost associated with managing invoice funders leading to double cost to service customers with factoring services. For P2P platforms, as a matchmaking service there simply is not enough margin left in the value chain to make the financial services provided affordable for normal businesses and to make the peer to peer factoring platforms financially viable and the investors in the platforms happy.
2. Anonymity stimulates fraud
Factoring has been around for hundreds of years and it has always been subject to fraud. Digital peer-to-peer platforms, by definition, are more anonymous and therefore more sensitive to fraud. As a provider of factoring services, you must be very careful with client onboarding. I’ve seen examples where people hired actors to pretend they were employees of a non-existent business. After these fake entrepreneurs convinced the factoring company to take over their invoices (and pay 90 percent of the amount upfront) they suddenly vanished.
In risk management it is very important to have a balanced approach using several approaches including credit risk tools, multiple data points for verification and experienced professionals that know the factoring business. At Factris, we believe in building relationships with our customer. We scale by freeing up our team from task that are readily automated.
3. It’s a relationship business
Technology has an unprecedented potential to allow people to work more efficiently. In fact, Factris’ business model is based on the premise that we should automate what can be automate; don’t spend man hours on tasks that computers can do more efficiently. What computers actually can’t do, is build relationships with people. After all, factoring is a local business based on relationships where trust is important. Automation should never mean losing contact with your clients. Similarly, entrepreneurs should know the people behind the factoring company that is in touch with their clients to collect invoices on a daily basis.
Actually, the three reasons mentioned above are closely intertwined. At Factris we strongly believe that automating parts of our business allows us to have better and closer relationships with our clients. Because our clients know that they are appreciated by us, they tend to stay for the long term.
Our personal approach to factoring allows us to offer competitive pricing while staying profitable; we aim for long-term, close and strong relationships with our clients.
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