The year 2006 saw a strong return of attention by companies, the media and consumers for Internet-enabled business ideas - the so-called Web 2.0 phenomenon. Web 2.0 emphasizes online collaboration and sharing among users with forms of many-to-many publishing, like Flickr, a photo sharing website, MySpace and Facebook, social networking websites, and YouTube, a video sharing website. One of the new Internet firms grabbing headline attention was Zopa, a UK-based peer-to-peer (P2P) online brokerage that coupled British residents who wanted to lend with those who wanted to borrow. Lenders proffered money not to individuals but to a pool of people grouped together because of similar creditworthiness. Launched in March 2005, Zopa started with just 300 members, but within just a few months had grown to more than 25,000 users. By November 2006 more than 120,000 people had signed up.

But what are the mechanics behind such a success? How did they identify this opportunity and did they pursue it? What are the key elements of this innovation and is it here to stay?

The Birth of Zopa

Zopa was co-founded by CEO Richard Duvall, chief financial officer James Alexander and ‘business architect’ David Nicholson. Duvall passed away after a battle with cancer in October 2006, and Alexander took over at the helm of the company. All were involved with Egg, the online bank. The company received more than £16 million in startup funding from Benchmark Capital (also backed eBay), Bessemer Venture Partners (also backed Skype), Wellington Partners and private investors.

Zopa stands for ‘Zone of Possible Agreement’ which is a term from negotiation theory. It refers to the overlap between one person’s bottom line (the lowest they’re prepared to receive for something they are offering) and another person’s top line (the most they’re prepared to pay for something). In practice, this approach underpins negotiations about the majority types of products and services.

The idea for Zopa was born from market research conducted by the company’s founding team that showed there was a potential market of "freeformers" to be tapped in the retail financial services industry. “Freeformers” were defined as self-employed, project-based or freelance workers who were not in standard “full-time” employment. Consequently, their incomes and lifestyles could be irregular, although they may still have been assessed as creditworthy. These individuals were identified as being either underserved by, or non-consumers of, the services offered by existing financial services institutions. Zopa’s consumer research indicated a large number of freeformers in the United Kingdom - possibly as many as 6 million “freeformers” of a total UK population of around 60 million.

The Zopa Operating Model

People joined Zopa online as either borrowers or lenders. Once registered, lenders could loan money to a pool of people grouped together because of similar creditworthiness. Zopa assessed the credit scores of borrowers using the same Equifax-based credit ratings as used by UK retail banks and lenders, and only offered services to borrowers who achieved an A*-, A-, B- or C- rating. The company also engaged an identity checking agency to verify the identity of all lenders and borrowers. The company’s own team of underwriters individually assessed each borrowers ability to repay, and borrowers were then entered into Zopa’s own market making system which included A*, A, B and C lending pools. Zopa had applied for patents in the UK for software elements of its proprietary marketplace matching platform, but recognized that the broader concept of ‘P2P lending’ could not in itself be protected from imitation. Two other peer-to-peer lending sites (donjoy.net and prosper.com) had already been established in Korea and the United States.

The main benefit for borrowers was that they could borrow relatively cheaply over shorter periods for small amounts. This was the reverse of banks, where lending typically became progressively cheaper for larger amounts over longer periods. The average interest rate on a Zopa loan in 2006 was a little less than 7 percent – cheaper than the credit card and loan rates offered by most banks. For Zopa lenders, higher returns were possible than through traditional savings accounts if there were no bad debts - typically in the range of 20% to 30% higher than putting money in a bank term deposit account. Lenders could choose the balance of risk against return they required. While waiting for their money to be lent out, lenders earned 3.75% interest on the balance of their membership account.

Zopa charged borrowers a fee of 0.5% of their loan amount and lenders a 0.5% annual service fee. Zopa deducted the fee from the holding account balance on a monthly basis, once the lender had received the monthly repayments from their borrowers. Zopa also earned money through selling payment protection insurance to borrowers who wanted it, and through referring people who could not borrow at Zopa (due to a poor credit rating) to other loan providers.

Value innovation in an established industry

Zopa represents what has been termed by Kim and Mauborgne (1999) as a ‘value innovator’. Value innovation is based upon one or more important innovations: the elimination of value elements that an industry has offered as standard; the reduction of value elements below an industry’s standard; the raising of value elements well above an industry’s standard, and the creation of elements that an industry has never before offered or even thought of.

Zopa eliminates the need for consumers to work with traditional financial institutions in accessing credit, and also eliminates the requirement for many of the face-to-face interactions and manual processes that have traditionally been part of the borrowing experience. Zopa reduces the breadth of products and services on offer, and through its low-cost structure is also able to reduce the costs and charges typically associated with borrowing. In parallel, Zopa’s low cost structure enables it to raise interest rates for lenders. The company also raises flexibility and transparency for customers well above the industry’s standard, as customers can borrow smaller amounts over shorter periods, and are not charged additional fees if they repay early. Individual lenders can actively monitor the performance of their loans, and track repayments by borrowers. The model creates a ‘social’ aspect to borrowing and lending by building a membership community – an aspect which has been largely absent from the sector in the past. The Zopa slogan of “economic return and social reward” incorporates this idea and prominently positions the social aspect.

As part of the new Web 2.0 phenomenon, Zopa has achieved value innovation in the retail financial services industry. By mid 2009 Zopa had launched in Japan, US and Italy, they now offer special services for affinity groups and are actively engaged in social markets like social housing projects. They are opening up to so-called power lender, small businesses, and even institutional lenders. By now other peer to peer (P2P) lending platforms are filling the market space like smava in Germany, Prosper in the US with 890.000 members or Boober in the Netherlands. Looking at Zopa as an example for a value innovation it becomes obvious how important it is to rigorously ask a set of fundamental questions when setting up a new business that wants to clearly differentiate itself from the existing solutions / products on the market. What are the value elements that can be eliminated, what elements can be significantly reduced below the existing standard, what other elements should be raised, and is there the chance to create new value elements like social reward or belonging in the case of Zopa, that can be created? These questions will help you to create a true value innovation.