Fintech investments on the African continent exceeded $1.35bn last year. The question now is whether a lack of incumbent legacy systems can help propel the sector further.
It is a familiar story: an expensive legacy infrastructure creates friction, but new market entrants avoid this and quickly surpass incumbents.
History has many examples: the UK was the birthplace of rail transport but around the globe, other rail services are far superior if we measure relative quality, speed and affordability. Imagine starting again with a blank sheet of paper to redesign our power supply and water distribution systems – so many improvements could be made.
No one can see into the future, but we can analyse trajectories of change. In financial services, the digital trajectory is clear and a leapfrog opportunity becomes obvious in emerging economies where little traditional infrastructure exists. Surely the ability to move straight to a light touch, low-cost service model is possible by riding the wave of mobile phone penetration, the availability of low-cost communication networks and a fast-growing young population. This is Africa’s opportunity.
A leapfrog opportunity becomes obvious in emerging economies where little traditional infrastructure exists
Fintech investments on the African continent exceeded $1bn in 2019 and $1.35bn last year, so this is a nascent, fast-growing sector. But can we see fintech companies achieving scale in markets where, on the face of it, incumbent legacy systems are not a barrier?
Mobile payment system M-Pesa is a good example. Launched 15 years ago by the mobile network operator Safaricom as a simple person-to-person (P2P) money transfer system, today it serves more than 30 million people in Kenya. It is now much more than a P2P system; people use their digital balance for a vast array of financial services including accessing credit, making savings, and paying merchants. Many of the people who use M-Pesa today previously had little access to financial services.
M-Pesa is one example of an African fintech play that has scaled, but what about others? This is the topic of a research project at London Business School (LBS), co-funded by the Foreign, Commonwealth and Development Office and LBS’s Wheeler Institute for Business and Development. The primary research area was why and how fintechs scale in Africa.
The Wheeler Institute research team looked at more than 700 companies, categorised by type into one of four broad groups: infrastructure, payments, lending and services. Using an index methodology, it was possible to determine if scale had been achieved using numbers of customers, but also size of the employee base, funds raised and revenue.
The results suggest that only 5% of African fintechs had achieved scale. This seems low, but it is necessary to take account of the relatively young age of the sector, and the obvious fact that Africa is made up of 54 countries with varying approaches to financial regulation. Establishing a successful fintech project in one jurisdiction does not necessarily make it easy to successfully establish it in another.
Other challenges to scale exist, not least the fact that most households have low disposable income compared with Western markets. Competition for a share of that wallet is fierce. Products have appeal when they offer solutions to real day-to-day problems.
More than half (51%) of scaled African fintechs are based in just three countries: South Africa, Nigeria and Kenya. Nigeria and South Africa are two of the largest economies in Africa, so their success is perhaps unsurprising. Kenya is an interesting case, and the runaway success of M-Pesa may have attracted investment in other fintechs.
In comparison with other index categories, fintech companies in the infrastructure category had the greatest prevalence of achieving scale. Infrastructure companies provide basic rails upon which other solutions can be offered. These can create an incumbency advantage through network effects once established.
The research illustrates just how complex it is to navigate the real economies in Africa, despite the allure of a digital leapfrog opportunity. Subsequent outputs from the project will examine why some fintech companies manage to scale in Africa, when most do not. For example, early results suggest that those companies that scale are not ‘asset-light’: they invest in physical channels and ensure that their customers can access cash (as opposed to relying on digital transactions). Cash is a long way from being replaced in most African economies.
The Covid-19 restrictions of across Africa, which have led to curfews and travel restrictions, have certainly accelerated the move to digital. Profitable pockets of opportunity may well exist within certain value chains that are ripe for change, such as the massive informal retail sector and the crucial agriculture sector. New entrants, as well as incumbents, will be eyeing these opportunities as they look to the future.
Rajesh Chandy is professor of marketing at London Business School and academic director at the Wheeler Institute for Business and Development.
