By Neil Patrick
Does technology have a moral compass? I guess most would say it’s morally neutral. It is the people creating it who must carry that responsibility. But technology and big data is the great power of our age. And with great power comes great responsibility.
When someone tells you big data is the answer, it’s smart to look beyond the data
This week Wonga.com went into administration. It’s a business I’ve watched with interest since its foundation in 2006. But not with admiration, rather a growing unease that its business model wasn’t just unethical, it was fatally flawed. It was bound to have a messy ending.
Wonga was the UK’s biggest payday lender. Payday loans in the USA remain illegal in 14 states yet created several multi-millionaires there in a few short years. And as is usually the case, when that happens, the idea travelled across the Atlantic very quickly to the UK.
Not very long ago, Wonga was a posterboy for the fintech sector. They invested in lavish TV commercials. They sponsored Newcastle United Football Club for £8 million a year. And they were once courted by investors eager to share in their profits.
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| Papiss Cisse of Newcastle United. Photo credit: Dudek1337 |
And Wonga's founders would be the first to admit that they trusted data and algorithms more than people. Couple big data with a fast and simple internet-based application process and Wonga were sure they would be the next big thing in money lending. They would take a proven business model from the US and turn it into a data-driven internet giant in lending. Tech is so much cheaper and more reliable than people after all. Or is it?
It all went horribly wrong for reasons which are not the same as the ones talked about in the mainstream media. They give you the headline facts. I’m more interested in what created those facts…
A short history of payday loans in the United States
Banking deregulation in the United States in the late 1980s caused many small community banks to go out of business. This created a void in the supply of short-term microcredit, which was not supplied by mainstream banks due to their unprofitability. That unprofitability was easy to explain – banking regulations wouldn’t permit the ultra-high interest rates needed to cover the high default levels that such loans inevitably create.
The payday loan industry sprang up to capitalise on this void and to supply small short-term loans to the working class at very high interest rates. But how was it that they were able to make these loans when banks could not?
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| W. Allan Jones, the 'father of payday loans' |
In 1993, Check Into Cash was founded by Allan Jones in Cleveland, Tennessee, and became the largest payday loan company in the United States. He’s known as ‘the father of payday loans’ - I am unsure if this is a tribute or an indictment - and his business was made possible only after he donated to the campaigns of legislators in multiple states, convincing them to legalize loans with such high interest rates.
And thus a massive new industry was born…
Subsequently, the industry grew from fewer than 500 storefronts to over 22,000 and a total size of $46 billion. By 2008, payday loan stores in the United States outnumbered Starbucks shops and McDonald's fast food restaurants.
And this was the point at which two entrepreneurs named Errol Damelin and Jonty Hurwitz envisioned an internet-based payday loans business in the UK. Both had previous internet start-up experience; but critically neither had any experience of retail banking. I could see exactly how Wonga would make money. I had no doubt about that. What I could also see was that the business model was completely unsustainable.
What exactly are you disrupting?
Wonga claimed and possibly believed they were disrupting big banks. They were not. They were actually disrupting doorstep money lenders and loan sharks; some of the most odious and exploitative businesses you will find.
And guess which other online sector is also in trouble today? Online ticket sellers. They claim they are making event tickets more easily available. But they are actually using all sorts of devious online trickery, enabling inflated prices not to mention a raft of fees and charges which are added to the bill. If they are disrupting anyone, they are disrupting ticket touts and making a killing in the process.
And just like the payday loans sector who became the target for heavy intervention by the Financial Conduct Authority, so too are the secondary ticketing websites, including Viagogo, StubHub, GETMEIN! and Seatwave. All are now under similar legal and regulatory threat by the Competition and Markets Authority.
So when new businesses say they are disruptive, that’s not automatically a good thing. What matters is that the disruptors are challenging an expensive or exploitative sector, remedying the fundamental failures of that sector, not amplifying them through mere digital deployment.
Investors loved this business – at first
In 2008, when Wonga was still an early stage start up, I was doing the rounds of venture capital firms in London, capital raising for another fintech startup. I distinctly recall one venture capitalist telling me that what he really wanted was another Wonga.
Wonga had already raised £3.7m to fund its initial platform development. In July 2009 Wonga raised a further £13.9m of funding through other VC firms (including the one I talked to). These investments enabled Wonga to complete their first platform and begin lending money.
The point here is that investors are looking for a quick return on their investment. Usually a sell out or exit after 3 - 5 years. They want a deal they can buy into cheap, and sell fast with a big return. This rapid rate of buying in and selling out enables them to avoid possible regulatory trouble because:
Regulators are far too slow to intervene to remedy exploitative practices
As I was watching the growth of Wonga and other payday lenders, I was also watching what regulators were doing. One of the first to take any notice was the Office of Fair Trading. Yet in their initial reviews they claimed that they had too few complaints to merit any sort of intervention. Instead they opted to merely keep an eye on things. It wasn’t until 2012 amidst explosive growth of payday lending and mounting criticism, that the Financial Conduct Authority decided to intervene.
The Financial Crash of 2008 was great news for payday lenders
Although when Wonga was founded, the financial crash of 2008 was still ahead, when it came, this event was to ensure that payday lenders were to benefit. Banks and other mainstream lenders stopped lending to virtually everyone. But people’s need to borrow didn’t diminish, which left Wonga with suddenly much less competition from more traditional lenders. Moreover, the economic doldrums which ensued in the Great Recession created new customers in their droves.
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| Screenshot from Wonga.com showing the cost of borrowing £100 for 30 days as at 17 Nov 2013 |
In 2012, a typical loan from Wonga had an annual percentage rate of 4,214 per cent. This equates to a charge of £42.96 for borrowing £100 for just 36 days. The debate still rages about this. Payday loans are by definition very short-term. And small. But most traditional loans are bigger and long term, so historically, the annual percentage rate of interest (APR) was a convenient and appropriate way to measure the cost of a loan. Not so much when the loan is for just a few days. My view was and remains that APR is not relevant when assessing the cost of ultra-short-term loans.
No-body wanted to buy Wonga because other predators were eating it…
In September 2012, Wonga reported profits of £45.8m for 2011 from revenue of £185m. But the threats and cracks were already showing. Not least of these was the Financial Conduct Authority’s new rules and ongoing investigation into the whole payday loans sector.
Already anticipating a new financial compensation opportunity, legal claims management firms saw that payday lenders would become their next carcasses to feast upon. And they were right – payday loan regulation created a whole new raft of claims opportunities. Coupled with the capping of the fees that had originally made Wonga so profitable, these claims grew and grew until the business became unsustainable.
Last week in a desperate last hour bid to save the Wonga from collapse, the shareholders stumped up a further £10m. But it was not enough.
Never leave the techies in charge of the business
The mainstream media, politicians and even the Archbishop of Canterbury have complained endlessly that Wonga’s business was exploitative. I agree, but that’s not how the business made so much money. The key to business’s early profitability was NOT through its high interest rates, but the fees and charges it applied to every borrower that failed to meet their repayment terms faultlessly and the rolling over of these charges into new loans.
Before regulators stepped in to tackle this in 2012, if a customer failed to repay the loan in full on the due date, a default fee would be charged and interest would snowball the debt endlessly thereafter. The debt would then be ‘rolled over’ into a new and bigger loan. Such things would involve a lot of letters and phone calls of course. And every letter and phone call would also incur a large fee which was also added to the debt. In the matter of a few weeks, a smallish loan could be transformed into a debt many times larger. This was insanely profitable.
Regulation is inevitable but is always too late
On 28 November 2012, following concerns that small loans, intended to be short-term, could become prohibitively expensive, the government announced it would give the Financial Conduct Authority powers to prevent indefinite rolling over of loans and effectively limit charges.
By this point, Wonga had already made millions in profits. But from this point, their business model couldn’t work. It was just a matter of time until the whole thing crashed. The only thing that surprises me is that the business was able to limp on for another six years.
When the body falls, the vultures complete the kill
The coup de grâce that finally finished Wonga ironically wasn’t it’s business model. True, this had become fatally wounded by the imposition of regulations to prevent their loan roll overs and excessive fees for defaulters. What finished them was another group of predators – the claims management companies. In 2014, the firm introduced a new management team and wrote off £220m worth of debt belonging to 330,000 customers after admitting giving loans to people who could not afford to repay them. But even this was not enough to deflect the inevitable.
The endless cycle of financial ‘innovation’, profiteering, regulation and collapse
Wonga is more than just a tale of dubious morality. It is a perfect demonstration of how a purely technological vision, lacking depth of understanding of the industry sector and its unique characteristics, inevitably wrecks the lives of customers, investors and staff alike.
I am pleased that Wonga is no more. But I am not optimistic that we won’t see this cycle perpetuating again and again in other business sectors. It’s not entrepreneurial innovation or disruption, it’s a perfect storm of lack of morality, self-delusion, arrogance and greed, going unchallenged until long after the damage is done. And as usual the biggest victims are those least able to bear it.
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