How do banks make money? There are lots of plausible answers to this question. They pay 0.2% on deposits and lend at 4%-plus, for a start. Or they take a small quantity of their own funds, add loads of borrowed money and use the debt to amplify the return on their equity, much as you would (as long as prices go up) by buying a house with a small deposit and a large mortgage. Or they provide essential services that generate a steady income, such as payments, and then try to sell each customer as many additional products as they can.

 

Depending on how you slice it, there are numerous ways to describe the business of making money for a bank. But one that you won’t hear very often is to concentrate on selling a single product to as many customers as possible. P2P lending, by contrast, is dominated by precisely this model – single-product platforms seeking to own a particular niche. This is interesting because I’ve lost count of the number of times people have explained to me that banks make little or no money on certain lines, such as standard term loans to small businesses, for example. Instead, these are supposedly seen as ways to deepen the relationship with the customer and open the door to other, more profitable conversations. It’s the portfolio that delivers the profit: within it there will be loss-leaders and cash generators.

 

Of course, one reason why a bank might struggle to make money on a particular activity could be its overheads. This is where P2P platforms gain a significant advantage – lower operating costs, notably the absence of a branch network, can allow them to survive on a tighter spread between the returns they offer to lenders and the interest they charge their borrowers. Less generous spirits than me might also suggest that banks deliberately sell some standard products at a loss to discourage would-be competitors, and cross-subsidise them from other business lines.

 

I’ll leave you to decide what to believe on that score. The important point is that P2P platforms’ ultimate profitability and valuation will be decided in large part by the relationship between the amount they spend to win each new customer and the amount they ultimately make out of that relationship.

 

If you have to spend a fair bit to attract a customer and you only have one product to sell to them, the relationship between your cost of acquisition and the lifetime value of that customer will not necessarily look very appealing. If you had two or three products that you could offer, either at the same time or progressively as the relationship develops, you could offset your cost of acquisition against a bigger ultimate revenue stream – bingo, the ratio will start to look a lot more favourable and so ultimately will your valuation.

 

I’m not altogether surprised, therefore, that I’m hearing an increasing amount of talk suggesting that several platforms are looking at introducing additional product lines in order to make more money from existing customers, rather than just chasing new business with only one product to sell. Another way to achieve the same effect could be to merge platforms with complementary products and take out as much cost as possible.

 

As the P2P business gradually starts to mature, I expect the focus on cost of acquisition versus lifetime value to sharpen considerably.

 

Update: Hot on the heels of last week’s note on institutional money and the growth of listed investment trusts that specialise in P2P lending comes news that the pioneer of this breed, P2P Global Investments, is considering another share sale to raise more funds for lending. P2PGI’s last fundraising, which pulled in £250m, took place only four months ago. Expect plenty more in the months ahead.