By Brian Waswani Odhiambo, West Africa Director at Novastar Ventures

Moving to Lagos from Nairobi three years ago, I thought I knew a bit about fintech in West Africa. Turns out there was more to learn.

In Kenya, innovation in financial services was led by the telcos. It was M-Pesa that provided the foundations for other fintech and embedded finance companies to build on and Safaricom opened up its application programming interfaces (APIs) to facilitate them. Today, your M-Pesa wallet enables you to make payments, save, and get credit. Over the last five years, banks in Kenya have been working to catch up but mobile money remains the market leader.

Nigeria took a different route

In Nigeria, traditional banks lead innovation with services like instant interbank transfers, USSD banking and customer credit. While corporate banking became the real cash cow given the massive industry built around the oil and gas sector, retail banking in this country of 200 million+ people was a luxury that only the middle and upper classes could afford. This left a massive swathe of consumers and businesses out in the cold.

The Nigeria Inter-Bank Settlement System (NIBSS) was the earliest innovation led by banks and the regulator. Launched in 1993, NIBSS made it possible for payments across individual bank accounts (P2P) and from individuals to businesses (P2B) via card and transfers. To date, NIBSS remains a key enabler of the fintech industry in Nigeria although other switches built by companies like Interswitch and TeamApt have subsequently entered the market. Remita, Transact, UP and Interswitch were also early players in the fintech game, enabling better interaction between bank customers and their bank accounts and eventually, the ability to make payments via point of sale terminals.

The history of fintech in Nigeria is well-documented but the main focus was initially on deepening relationships with existing customers rather than expanding access. This initial focus was too lucrative to diversify from and banks were then too big, too slow and too expensive for the “many”.

Enter the next generation of fintechs

These companies were nimble and well-funded with the benefit of international support in terms of capital and knowledge. Instead of building a challenger bank, they focused on operating specific verticals within existing banks and doing it better. For example, Carbon, Lidya and FairMoney all took a laser-focused approach and became really good at assessing borrowers quickly; lending to even the smallest of businesses that banks were not interested in. Other companies – Paystack and Flutterwave – took on payments, specialised and scaled up, gaining significant market share.

Inevitably, the available market within specific verticals shrunk with increasing competition and now, new age fintechs are reverse-engineering to where it all started – banks. Once you excel at a specific offering and have a captive audience, upselling your customers is the obvious next step, and over the past two years more than 10 fintechs in Nigeria have acquired or are acquiring a microfinance bank license.

The difference this time is that the fintechs are well-capitalised risk-takers interested in scale, and they can scale more cheaply given they don’t need to build expensive bricks and mortar branches. This has been great for Nigerian micro businesses historically ignored by banks. Helping small businesses get online with an affordable one-stop shop that provides all the products they need – payments, credit, FX, and business management tools – is a massive opportunity. There are 40 million microbusinesses in Nigeria, each employing between one to five people. That’s a big enough market to build pretty large financial institutions.

It’s a similar story with B2C

In Nigeria, and sub-Saharan Africa generally, money doesn’t sit in people’s accounts. Once you’re paid you withdraw the money in cash, or in the case of East Africa consumers, transfer it to a mobile wallet. In Nigeria, cash remains king and although transfers are increasingly becoming popular for payments, the vast majority of individuals prefer to pay or get paid in cash. This is compounded by a lack of trust in the infrastructure for paying and transacting, which constantly fails or is glitchy. In East Africa, by contrast, many retail outlets will accept mobile money and the infrastructure works 99% of the time so people are happy to use it. The wallet also offers additional products such as credit, savings and rewards.

Some fintech companies operating in Nigeria – Kuda, Chipper Cash, MFS Africa – have tried to go after the retail market but the jury is still out on whether that will be profitable long term. There was inevitably a land grab with some companies looking to grow their top line customer numbers with the hope that at some point they could monetise these. This hasn’t happened quite yet. Millions of downloads have not translated to the uptake of other services and even when they borrow, often customers don’t re-pay and enforcing repayment is very difficult.

So what’s next?

As well as leading Novastar’s investment in TeamApt, I also go to many fintech conferences, read a lot of blogs and speak to founders in order to identify the “next big thing”. As an investor, I naturally want to be ahead of the curve. To be specific, I’m not usually asking about crypto, decentralised finance or how blockchain will have new applications in fintech. I am trying to understand what current products, operational and business models will look like in the next three to five years. Common themes emerge:

• Product and customer service are key. While one can compete on price to create stickiness, that’s typically a race to the bottom especially in this new world where companies are raising tens of millions of dollars in investment capital. Product and customer service are the main drivers of stickiness. If, for instance, you have a point of sale (PoS) service that fails a few times, customers will switch to an alternative provider. The transaction cost for the customer is just too high and they are inundated with options that are sometimes even cheaper.

• Fintechs will need to do more than just financial services. This means getting into adjacent offerings including insurance, remittance, business management tools. etc. Payments and credit are the bread and butter for a lot of fintech companies but these are increasingly competed with little differentiation. Deepening the relationship with the customer (microbusiness) via additional offerings is the way to stay ahead.

• Banking the end user (B2C) will be crucial. So far, a direct to retail model hasn’t proven successful for fintechs in Nigeria but they will need to find a distribution model to reach end users and generate value from them. This could mean banking the employer and the employee for example, with benefits to both parties.

So, what’s the role of investors?

The ecosystem is at a point where we’ve got pretty sophisticated fintech founders with strong engineering backgrounds and a sound understanding of the market. This is, in part, because most founders today come from some of the fastest growing fintech companies on the continent. TeamApt, Flutterwave and Paystack all boast alumni who have gone on to build amazing fintech businesses.

Increasingly, generalist investors will not move the needle for these companies. What the market will demand is specialised expertise which could include specific fintech product know-how, experience launching in new markets, regulatory expertise, knowledge of hiring engineering teams or exiting businesses, among others.

There remains a large funding gap in the continent and I do not mean to discourage investors looking into these types of businesses. However, the market is maturing and if we can learn something from growth stage businesses, they eventually need subject matter experts to really take them to the next level.

Two things keep me optimistic

Firstly, I know we’re barely scratching the surface – not only in the range of financial products that consumers require but also in the geographies. Outside the headline markets of Nigeria, Kenya, Egypt, South Africa and Senegal, people across Africa continue to buy and sell. These individuals present an untapped market for fintech companies looking to enter or expand in Africa.

Secondly, fintech is an enabler. The infrastructure that many fintech companies are establishing today will unlock a lot of value for other companies to build on. For example, buy-now pay-later – this only works if you have the infrastructure to collect digitally. Or lending to farmers – you get the credit lines working and then an agtech business can come in and embed its services. This layering is what will build a genuinely robust and resilient market, with fintech at its heart.

This article was first published by Novastar Ventures.