Wonga – In Praise of Its Efficient Transactional Management

My US-based colleague Thomas Kase wrote recently about an offer of a loan he got through the post. He thought it was appalling that the firm offered an APR of 29.99% - why would anyone go with such a high interest rate he wondered? I guess Wonga and the other UK pay-day lenders haven’t made it to the US yet, or Thomas would not be so surprised or horrified!

"29.99% interest rate - we used to dream of 29.99%", as Monty Python's four Yorkshiremen might have said. Have a look at the Wonga website and see that you can borrow £150 for 18 days, pay back just £183.49. That represents an APR, believe it or not, of a mere 5,853%!

But there is another way of looking at it. I don’t have much time for Wonga, but you might ask a couple of questions. Why have they been able to compete successfully with the traditional pay-day lenders? (That is, large men with big dogs who took fairly direct action if you couldn’t repay, and charged even more than Wonga). And why haven’t the mainstream banks moved into this market, which is obviously proving lucrative for Wonga and others?

The answer lies in technology. When you look at the cost structure for making a small loan of £150, over a short period of time, the financing cost of the money is neither here nor there; it is immaterial. The costs of executing the loan lie primarily in the administration and then in the risk of default. Think of applying for such a small loan just a few years ago with a traditional bank. Going into the branch, meeting someone perhaps, filling in lots of forms that have to be processed by the bank... and so on.  And all to make a revenue (not even a profit, just a revenue) of some £33.49. You could not make money on that.

But Wonga can. By automating the process, slick and effective technology and no doubt being clever with their risk algorithms (so they turn down the right people), their transaction cost is clearly very low. So they can make money even at those small amounts of borrowing. Wonga only go up to £400 for 43 days as their maximum loan value and length, so we can’t really see if economies of scale kick in, but you would expect the APR to drop as more is borrowed. That's because the transaction cost stays pretty much the same, although the risk premium and of course the total financing cost rises.

There are some parallels here in our procurement world – think of fees for supplier networks, e-invoicing and similar processes. So for instance, handling low value invoices can be relatively very expensive as the transaction cost is pretty much the same whether the invoice is for £10 or £10 million.

Anyway, back to Wonga. I don’t like the fact that people are desperate enough to use their services, but actually, making money on a £35 fee, given the complexity of the transaction they’re undertaking, strikes me as rather impressive, from a purely technology and process point of view at least.

First Voice

  1. Grover + Ross:

    You’re charitably assuming they want the loans paid back on time.
    What if the profit is in those who don’t pay? – The poor sods who end up paying the loans back several times over.

    GROVER & ROSS can consolidate all your beatings into one, EASILY SURVIVABLE MONTHLY KICKING

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