Authors: Max Flötotto; Eitan Gold, Tunde Olanrewaju, Uzayr Jeenah; and Mayowa Kuyoro
Affiliated organization: Mckinsey & Company
Type of publication: Report
Date of publication: August 30th, 2022
Between 2020 and 2021, the number of tech start-ups in Africa tripled to around 5,200 companies. Just under half of these are fintechs, which are making it their business to disrupt and augment traditional financial services.
One industry leader we spoke with said that rather than a “fintech disruption,” the continent is experiencing a “fintech eruption,” and local and international investors are taking notice. African fintech is emerging as a hotbed for investment, with average deal sizes growing and the proportion of fintech funding in Africa increasing over the past year, bringing jobs and growth to African economies. And the story is only just beginning. As fintech matures, financial services on the continent are at an inflection point, and several African countries have a significant opportunity to capitalize on the momentum of recent years to unlock further potential in the sector.
African financial services are undergoing a structural shift
McKinsey analysis estimates that Africa’s financial-services market could grow at about 10 percent per annum, reaching about $230 billion in revenues by 2025 ($150 billion excluding South Africa, which is the largest and most mature market on the continent). Nimble fintech players have wasted no time carving out a share of this expanding market. As the fastest-growing start-up industry in Africa, the success of fintech companies is being fueled by several trends, including increasing smartphone ownership, declining internet costs, and expanded network coverage, as well as a young, fast-growing, and rapidly urbanizing population. The COVID-19 pandemic has accelerated existing trends toward digitalization and created a fertile environment for new technology players, even as it caused significant hardship and disrupted lives and livelihoods across the continent.
Taken together with an influx of funding and increasingly supportive regulatory frameworks, these factors could signify that African fintech markets are at the beginning of a period of exponential growth if, as expected, they follow the trajectory of more mature markets such as Vietnam, Indonesia, and India.
Growing African fintechs may face four challenges
Reaching scale and profitability
While the opportunity across the African continent for fintech growth is significant, in certain regions, the total addressable market (the relevant category of viable customers) is limited by infrastructure constraints. These typically include weak mobile and internet penetration in some markets, lack of identification coverage, and limited payment rails—the backbone of all digital transfers of money. Across Africa, just three countries have real-time payments and the necessary payment rail infrastructure in place.
Fintechs aiming to scale across the continent may need to take this geographic variability into account and tailor their approach to each country based on its inherent characteristics, infrastructure, regulatory frameworks, and varying customer needs and habits.
Navigating an uncertain regulatory environment
In addition to uneven infrastructure across markets, fintechs in Africa also have to contend with a fragmented financial regulatory framework. Different countries are evolving at different paces. While regulatory bodies in some countries are starting to support the development of an enabling environment—for example, by creating fintech sandboxes, updating licensing requirements, and implementing digital KYC regulations—in general, complex and variable regulations, including license approval processes, can make it difficult for fintechs to ensure business continuity and compliance across markets.
Fintechs may find that they can’t adapt fast enough in some markets to keep up with regulation, which, along with the degree of enforcement, can sometimes change quickly. In other markets, fintechs may find they are moving faster than the regulators, which creates a whole new set of challenges. Furthermore, entrepreneurs and investors can be exposed to fluctuating exchange rates and strict foreign-exchange control in some countries, which make it harder to maintain consistency.
Managing scarcity
Businesses don’t run on infinite resources. Time, money, and people need to be managed effectively to launch and sustain growth. After record-breaking fintech investment in 2021, funding is slowing down, especially for later-stage start-ups. But with incumbents starting to catch up with disruptors, fintechs can’t afford to slow down their progress. This suggests that African fintechs will likely have to tighten their belts to adjust to a new venture funding reality. Y Combinator (YC), a US-based technology start-up accelerator, has advised its community of over 7,000 founders to expect and plan for the worst, cut costs, and extend their runway because “during economic downturns even top-tier venture capital funds slow down their deployment of capital. This causes less competition between funds for deals that result in lower valuations, lower round sizes, and many fewer deals completed.” As a result, it may be necessary to find ways to boost local participation in venture financing. Currently, about 70 percent of fintech start-up deals are financed by investors headquartered outside of Africa, most of them in North America. Additionally, most locally financed deals are for early-stage start-ups.
Building robust corporate governance foundations
Ensuring world-class corporate governance is likely to be a critical factor in enabling fintechs to navigate this uncertain and fragmented terrain, manage scarcity, and successfully reach scale and profitability. An effective governance structure can help to build a strong, positive organizational culture that provides stability, clarity, and direction—even in difficult times.
There are three broad characteristics of a healthy corporate governance model: strong culture building, productive stakeholder engagement, and a clear talent strategy to build the organization’s capabilities. While matching a fintech’s value proposition to the right market may be a critical first step in building a successful start-up, to maintain momentum, it is necessary to define routines, norms, and processes that are shared and understood by everyone in the organization. In today’s world of hybrid working, this is even more critical than before. And because fintechs can evolve rapidly, it is vital that they have a well-developed compliance foundation to actively manage regulatory change and avoid falling foul of regulators—a challenge many are starting to face.
Africa’s leading fintechs share a common set of winning characteristics
Fintechs operating in Africa will know that there are no quick wins on the continent. In overcoming the common obstacles in their path, our analysis shows that the most successful African tech start-ups share six common characteristics with features that mirror those of successful global companies, and have also adapted their business models to the unique economic realities and customer needs of Africa.
First, given the variability between African markets, it is important that fintechs match their value proposition to the market they are entering. Globally, we have seen fintechs evolving to achieve scale through three major routes. Some start out as a distributor of unique nonfinancial consumer products and evolve into a fintech, while others start with a specific financial business-to-consumer (B2C) or B2B product and evolve into a digital bank. A third option is to start with a payment infrastructure solution and evolve into a national digital platform. In Africa, infrastructure constraints have meant that the continent’s oldest fintechs—for example, Fawry in Egypt, M-Pesa in Kenya, and Interswitch in Nigeria—entered markets by building infrastructure specific to a single country and, as a result, are now the market leaders.
Second, to achieve sustainable growth, companies that have a long history of operating on the continent have built their success on rapid customer acquisition. Africa’s fast-growing population of more than 1.3 billion people offers a large potential market for fintechs, but actually acquiring customers can be challenging because of factors such as infrastructure constraints and low customer purchasing power. Leading players have had to take steps to overcome such constraints by, for example, leveraging preexisting physical networks or by employing aggressive pricing strategies to offer cheaper fees and charges than competitors.
Third, once having acquired customers, leading fintechs have found a sustainable way to translate this into clear monetization strategies. Such strategies have one of two things in common: they either have a repeatable and healthy revenue source coming from core activities, such as card switching for Interswitch or serving merchants with point-of-sale for Yoco, or they have multiple monetization strategies, such as having a B2C arm for a B2B company or vice versa. For example, M-Pesa and MTN both have a strong lending component in addition to their wallets, while Paga has leveraged its strong position in wallets to expand into merchant acquiring.
Fintechs are required to pay attention to, and comply with, regulation. Many successful fintechs including OPay, M-Pesa, and Fawry have, after reaching significant scale, chosen to proactively engage with regulatory stakeholders so that they are able to move forward together
Fourth, a key marker of success in Africa has been the ability to adapt to the reality of low average revenue per user (ARPU), both in the consumer and micro-, small and medium-sized enterprises (MSMEs) sectors. GDP per capita in Africa is the lowest of any continent, and fintechs have adjusted to this by, for example, using scale to reduce the cost of serving customers, as M-Pesa has done, or changing the business model to pay-as-you-go for businesses that can’t afford advance payments, as Yoco has done.
Fifth, another African reality is that, with 90 percent of all transactions on the continent still cash based, successful fintechs have had to find ways to reach clients offline. Key strategies here have included building agent networks or using preexisting infrastructure such as physical shops for delivery of financial services. For example, South Africa’s first digital bank, TymeBank, overcame infrastructure challenges through a strategic alliance with major retailers. This has enabled the bank to place account-opening kiosks in retail stores across the country, bypassing the need for a physical branch network.
Finally, with regulators increasingly active in Africa, fintechs are required to pay attention to, and comply with, regulation. Many successful fintechs including OPay, M-Pesa, and Fawry have, after reaching significant scale, chosen to proactively engage with regulatory stakeholders so that they are able to move forward together.
Unlocking the potential of fintech in Africa
All the signs point to the culmination of African fintech’s first phase of development. Fintechs have become major players in the African financial-services sector (in some instances, rivaling traditional banks in terms of size and value), funding has increased, and value is being generated. In fact, the number of high-valued fintechs is increasing exponentially. Additionally, consumer access is at an all-time high. Today’s leaders have built the payment rails, effectively laying the foundations upon which the industry can grow, but tightening market conditions suggest that in their next phase of development, fintechs may need to adapt their focus as they look to consolidate and formalize to achieve enduring success.
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