P2P Lending’s Fatal Mistake

Matchmaker, matchmaker … make me a match.

If only it were that easy.

Or, if we were back in the good old “Fiddler On The Roof” days, the concept of the multi-sided platforms weren’t a driving topic of conversation. Even so, the idea of matchmaking — an age-old concept — is alive and well, but it’s rapidly changing as the concept of a two-sided relationship has evolved the very way consumers, companies and investors in the payments and commerce industries interact and work together.

And one of those rapidly changing topics that’s caused a lot of stir recently has been the evolution of online P2P lending marketplaces. Or, as the Lending Club saga has shown, how difficult it’s become to scale the business model to a level investors expect.

That, in part, was the focus of discussion between MPD’s Karen Webster, David Evans — co-author of the book “Matchmakers: The New Economics of Multisided Platforms,” recently published by Harvard Business Review — and Paul Purcell, Partner At Continental Advisors, in the latest installment of PYMNTS’ weekly series, The Matchmaker is In.

So to kick off the conversation, Webster asks Purcell one simple question: What went so wrong? It’s a complex question to be sure — and one which Purcell joked couldn’t be answered in a 30-minute chat. That didn’t stop him, of course, from pointing out — from his investor standpoint — some of how the P2P lending marketplace has gotten off-kilter.

“To be fair to the founders of that industry, I think they were really angling at trying to create a two-sided marketplace,” Purcell said. “There was not enough supply (dollars) to fund what was migrating to their platforms. They had a very innovative idea, but I don’t think their dreams of getting the funding supplies for those loans played out.”

Mispriced credit caused too much credit demand, he says, and that caused its funding model to be unable to keep up with demand. From there, the market seemed to unwind, he points out during the conversation. The lack of capital in this market, Purcell added, is very fickle, which added to further problems.

“The lack of stable funding is ultimately what was created. It’s really bad to unwind in businesses, whether it be consumer credit or mortgage business,” Purcell said. “When that starts to happen, the risks spread.”

Which goes back to one of the potential drawbacks of two-sided platforms.

“The power of network economies cuts both ways. When it goes south it tends to spiral hard, if not harder than it did on the way up,” Purcell noted.

Evans agreed, saying that “once you go down, it’s really hard to climb back up.”

The conversation also shifted toward regulation and how having regulators’ hands in the online lending marketplace has changed the game. If anything, the problem with financial regulation, Purcell says, is that it tends to be retrospective, which means determining what went wrong after the fact.

“Regulators are going to have to find out more real-time cadence on how to measure compliance,” he said. “One person’s innovation and operations is another person’s invasion. Just because something is new doesn’t mean it’s compliant.”

So when it comes to providing advice to innovators, something Purcell and his team know a lot about, Webster asks what type of advice he gives to innovators about how they should spend their time ensuring their newest product is going to get its day in the sun in the marketplace — while still being respectful of regulatory boundaries.

“When we talk to our portfolio people about it we always say, ‘You are much better off asking permission than begging for forgiveness,'” he said, noting that it’s time for everyone in these types of conversations to “get into a discussion around what those product sets look like and who those consumers are that they serve.

As for investing in matchmakers, Webster asks Purcell which type of matchmakers they want to invest in — and what they want to stay far away from. For the latter in that case, those are the businesses Purcell calls the “businesses that have very untested regulatory constructs,” or “very untested issuance performance metrics” behind them.

But for the better bets? And why the lending marketplace will always pose a challenge?

“I think the biggest place in terms of how we invest money it’s going to be the transaction-oriented provider of services, policing risk assessments in the marketplace economy. I think that it’s not just limited to this genre of marketplace lending. I think lending is going to continue to be a tough business. Whether there’s a matchmaker there I’m not sure,” Purcell says.

The question Webster concluded with — and one most critical to the conversations about how to facilitate a two-sided marketplace relationship — boils down to what this investor thinks about who is doing matchmaking right.

And even Purcell admits he hates to say the one company that’s almost become cliche in this argument. But he can’t deny that title goes to Uber, he said, specifically pointing to Uber Black Car.

“As much as a I travel, Uber really is magic. The elegance of what they’ve designed in simplicity and speed that I can go almost anywhere in the country and pick me up in a black car on-demand. The self policing of network,” Purcell says. “Uber Black Car is the absolute gold standard of what marketplace operations should be shooting for.”