Wonga – the Web 2.0 startup that’s cashing in on risk

Wonga has a simple model to make money by lending to those in need of short term spondulix. But it’s the risk assessment algorithms behind the scenes that could be the real cash cow for this business.

By
12th February 2009 at 9:07 pm

It seems like only yesterday borrowing was easy, banks made obscene profits and there was a never ending supply of money to meet our voracious appetite for consumerism.

Like George Best and Miss World in a hotel room full of cash and champagne, we had it all. But somewhere from a quiet corner a voice was telling us that it was all going horribly wrong.

And so today we’re faced with recession, while freudian slips suggest the ‘r’ word could succumb to the ‘d’ word before the year is out.

Errol Damelin of Wonga.com risking it all on a web 2.0 startup

Errol Damelin, founder and ceo of Wonga.com

A strange time then for a web startup with an in your face name for cash, Wonga, to be attempting to do what some of the largest most sophisticated financial institutions in the world have failed miserably at – lending money with minimum risk.

To be fair to Wonga and its ceo Errol Damelin, the service launched over a year ago when borrowing money was de rigeur, rather than a question of survival.

Nevertheless, one might reasonably ask has this startup got its timing all wrong?

Errol, a serial entrepreneur whose supply chain software business straddled the dot.com recession of 2001, is remarkably sanguine. He says:

As an entrepreneur you don’t pick the environment you have to work in.  You start to build a business when you have an idea and usually it comes to fruition in a different economic cycle.  You have to make the most of the cards you’re dealt.

The credit crunch might superficially look like a good hand for a business in the business of lending small sums.  

Wonga typically gives its customers a near instant decision on short term lending of a few hundred pounds.  

A kind of mini-bridging loan for people who’ve forgotten that pay day is a week away, but still want to take their loved one out for a slap up meal on Valentine’s day anyway.

But here’s the rub.  Short term money is expensive money. That’s good for Wonga’s bottom line, but may be hard to swallow for many who would otherwise be potential customers.

Wonga APRs are eye watering

The OFT demands Wonga displays an APR

Legally Wonga has to display a typical APR (annual percentage rate) which makes sense for bank loans or credit cards, but looks like a Zimbabwean inflation figure when applied to short term borrowing.

Annual compound interest of 2,334% is a scary figure indeed. But over the short term, if you borrow £135 from Wonga today, you’ll have to pay back £135 plus £26.29p 15 days later. Cheaper perhaps than punitive unauthorised overdraft rates charged by some high street banks, but still a hefty hit.

But this is micro-lending to people who can afford it.  Wonga is clear they are responsible, transparent lenders and for each loan taken out with them, they give a £1 interest free loan to Kiva, the micro-finance initiative which helps grass roots entrepreneurs in developing nations.

They are not offering a service to desperate individuals. They are lending to people who judge paying for the convenience of cash now, rather than later, is worth the price.

As Errol says:

It’s not dissimilar to catching a black cab.  Of course the tube or bus will be cheaper, but every-now-and-then a taxi’s more convenient, if considerably more expensive.

Not a bad metaphor. In fact, Errol admits that Wonga only lends to 1 in 10 people who apply through the site.

Which begs the question, are there really that many people out there right now who will want to pay a large charge for a small amount of money once in a while?

If younger people with disposable incomes start counting their pennies more carefully, then Wonga might be seen as an unnecessary expense.

Conversely if the service takes off dramatically, it might find the credit crunch starving it of the cash needed to lend on a large scale, even if profitably and at low risk.  Wonga’s ceo acknowledges this may cause them issues and restrict growth, if the lending markets are still frozen in 6-12 months time.

Wonga’s investors which include Balderton Capital (formerly Benchmark) must nevertheless be attracted to the cash-generative potential of the business (which already turns a profit), but also to the back end technology that takes the whole concept beyond simple money-lending.

Which brings us back to Errol Damelin’s first foray into business in Israel where he joined a founding team to build a new steel plant. 

A massive contrast to the low overhead, speedy startup world of the web, this was a big, capital intensive project.  But what it taught the Wonga ceo in his formative business years has clearly had an impact.

He has a strong sense of meeting the demand of real customers and a passion for planning, managing and automating complex supply chains to scale.  As he says:

If I hadn’t had that strong manufacturing background, I don’t think we’d have conceptualised Wonga in quite the way we did.

This attention to process and automation manifests itself in the apparently sophisticated algorithms behind Wonga. They’ve been designed to manage the risk of lending by lightning fast assessment of the credit-worthiness of customers and nimble analysis of data around their repayment behaviour.

The potential value of this intellectual property, if proven to work effectively, is clear.  

Selling short term loans is one thing.  Improving risk management in banking is something else altogether. 

You can almost hear the VCs at Balderton Capital licking their lips at the prospect.

#646464

Alex is the founder and editor of SmallBizPod, the UK's first podcast dedicated to small business, start-ups and entrepreneurship. Alex writes about topical small business issues, entrepreneurs and anything else that catches his eye here on the small business blog. http://www.smallbizpod.co.uk

Commenting Is Easy

Do you agree with this blog post? Disagree? Have something to add that others might find helpful? Then please leave a comment in the box below.

If you'd like to have your image included next to your comments here, then you can set yourself up with an avatar in just a couple of clicks.

  1. Pearl says:

    “looks like a Zimbabwean inflation figure…” Brilliant 🙂

  2. […] and entrepreneurs, has written a piece about Wonga and our sophisticated decision-making system. Read the blog, or here’s a brief extract: Wonga is clear they are responsible, transparent lenders and for […]

  3. Nina says:

    I’ve used Wonga twice and love the service. The first time, a friend had told me about the site because I’d literally just cut up my last credit card (determined to rid myself of plastic once and for all) but needed a couple of hundred pounds for a flight. I saved actually myself some cash by not waiting another week for my salary. It’s true they’re not cheap, but I feel it’s a price worth paying on the odd occasion where a bank loan is too much and will take too long to organise.

  4. charles parker says:

    I have used wonga on several occasions. They do what they say. I now use an alternative toothfairy finance, they are quicker and offer a better level of customer service.

  5. Claire says:

    @charles parker – As a Wonga customer and fan I was interested in your post because I’d never heard of Tooth Fairy Finance before today.

    Thinking you were on to something I went and checked it out only to discover that they are ever-so-slightly more expensive than Wonga.

    A search further found this thread:
    http://www.consumeractiongroup.co.uk/forum/payday-loans/196995-toothfairy-finance-i-need.html

    All this to say, I think I’ll stick with Wonga. They respond to my emails and they are less expensive.

  6. Claire says:

    To further my previous post – I understand it also mentions Wonga in that link and think it’s odd that Tooth Fairy Finance and Wonga are suddenly popping up in the same breaths.

    Makes me wonder if Tooth Fairy Finace isn’t out to dirty Wonga a bit wherever they can… A clever person will notice that the post by Brumgirl about Wonga was her first post – and she joined today.

    Hmmm….

  7. […] though, as co-founder Errol Damelin set out in an interview about Wonga with SmallBizPod earlier this year, it’s the startup’s automated financial risk […]

  8. james leighton says:

    Toothfairy finance is a great short term cash help. Great service, reccomend to everyone… wonga i found was very slow and not nice customer support, very rude staff 🙁

Leave a comment

Photostream

Listen to the sales podcast for SMEs Subscribe to the podcast on iTunes

PARTNER PROMOTIONS

If looking to boost your businesses performance with promotional marketing, travel incentives or incentive schemes get it touch with NDL Group