The 4 distribution models of digital financial products

May 18, 2016.

Distribution — well, profitable, scalable, and repeatable distribution — is key in selling financial products. LendingClub learned this lesson well: as distribution channels dried up for the firm’s consumer loans, the firm’s CEO created (and didn’t disclose) a fund that would buy these loans. The ending was ignominious — as the CEO stepped down, the Department of Justice stepped in and LendingClub’s stock price doesn’t stop going down.

Written by Zack Miller,Suman Bhattacharyya,Tanaya Macheel - Originally published at this link.

But the distribution issue is core to understanding why investors have grown skittish over Lending Club in particular and marketplace lending in general. Whether a firm is a fintech upstart or an incumbent financial institution shipping financial products, without viable distribution channels, new digital products can be dead on arrival.

Effective distribution channels should be profitable (lifetime value of the customer should surpass acquisition costs), scalable (a process that has room to grow larger in size) and repeatable (can you keep doing what you’re doing?).

There are 4 overarching models financial firms can use to distribute their products.

Piggyback Model: One way new products can find their way to end customers is via the piggyback model. At its heart, this is a marketing partnership where a financial institution partners with another institution (could be another financial institution or not) that owns the end user. This is essentially what On Deck Capital is doing with its partnership with JP Morgan: the bank owns the business customer and can relatively easily distribute the online lender’s products across the U.S. With shared economics, both parties benefit in this model.

Piggybacking non-financial distribution channels works well, too. Stockpile, a fractional stock brokerage, distributes gift cards redeemable in shares of favorite companies. When a customer at kmart or Safeway buys a $50 gift card of Amazon stock for his nephew’s bar mitzvah, the startup brokerage just acquired a customer through a piggybacked, offline distribution channel. The point is that the financial firm works in tandem with another entity that owns the customer to effectively deliver its product.

Inflection Model: This distribution model was written about recently by the people over at Andreesen Horowtiz. As an investor in fintech, the venture capital firm recognizes how paramount the issue of distribution is in getting a standalone finance company off the ground. AH encourages financial firms to market products or services at trigger events in customers’ lives. These inflection points can be lifecycle events (like graduation), a point in time (immigrating to a new country) or a micro-event (a major purchase). By finding these inflection points, firms can typically find a way to pull (vs. push) customer demand and do it in a way with lower acquisition costs.

Because financial products are typically sold and not bought, customers require something on their end that moves their “dissatisfaction threshold” so much higher that they’re finally open to switching products. When a firm times its pitch at one of these points, it should find ready, willing, and able buyers of its products. Online lender, SoFi pioneered this model by targeting HENRYs (High Earning Not Rich Yet) — recent high-potential graduates saddled with student debt. These prospects are amenable to an offer because of where they are in their lives and if successfully delivered, they should be open to other lifecycle-type loans. That’s why the firm has rolled out personal loans, mortgages, and investing products as complements.

“The best inflection points occur early in a customer’s life, when it’s easier to become that person’s primary provider of financial services. Such early-lifestage customers probably haven’t been with their current provider for a long time (so they’re easier to switch) and haven’t yet adopted many of the products they’ll need in the future (easier to upsell),” Angela Strange and Alex Rampell wrote recently on the company’s blog.

App Store Model: Some technology firms are working on finding a way to provide digital solutions for very discrete parts of banking. Delivered via APIs, these unbundled banks have a clear model for distribution. Like Apple’s App Store, these firms act as technology clearing houses that other financial institutions or consulting firms can use to integrate software and feeds into their own applications. The app store model, employed by firms like Plaid, essentially creates a la carte software offerings of banking services. Customers like acorns and venmo merely need to integrate Plaid’s solutions into their own applications. It’s like the piggyback model in that it uses indirect channels except it’s not B2C — it’s B2B or B2B2C.

Max Levchin’s Affirm, which provides financing for consumer purchases, is also using the app store model to distribute its products. The startup has found a way to integrate its tools into firms like Expedia and Eventbrite. In this way, when a customer is nearing completion of a transaction on an ecommerce site, they’re offered an option to create a payment plan to finance their purchase. The app store enables digital financial products to be fully integrated into another firm’s technology product to reach end users.

Machine Gun Model: Alas, the machine gun model is what some of the more plain-vanilla online lenders have used to distribute their products and grow their companies. Marketplace lenders like LendingClub and Prosper have been big users of direct mail marketing, sending tens of millions of pieces of snail mail to potential borrowers throughout the U.S., encouraging them to apply for loans on their platforms. But, as recent events have shown, it’s hard to build a scalable, repeatable, and profitable distribution channel this way.

Photo credit: F. Berkelaar via Visual hunt / CC BY-ND