How to think about market size in Nigeria

A few weeks ago, we looked at the philosophy behind valuing startups and drew related important conclusions. The first was that valuing early-stage startups in early-stage ecosystems is closer to analysing abstract art than calibrating mathematic equations. The second is that even if these valuations are nonsensical, they are extremely important for the ecosystem.

Since that conversation, a lot has happened in the Nigerian tech ecosystem; some good, some bad.

We celebrated MTN MOMO’s Payment Service Bank (PSB) license and the telecoms giant’s imminent foray into Nigeria’s financial services industry. We also celebrated $2.3 billion coming into the African tech ecosystem between January 2022 and March 2022, 44% of the 2021 value and already more than in 2019 ($2 billion) and 2020 ($1.4 billion).

Fintech especially has been on a tear. $793 million of that $2.3 billion (a third) went to fintechs, with Nigerian fintechs alone raising $426 million in the first quarter of 2022, more than they raised in the whole of 2020 ($323 million), and three-quarters of the total fintech funding for Africa in 2019.

Not all days have been sunny in the ecosystem, though. The Flutterwave scandal is a blot on the ecosystem’s copybook, given the company’s prominent role in the ecosystem. More recently, global tech stocks and investment markets have tanked. Amazon shed $200 billion of its market value in a single day in April—or half Nigeria’s GDP, Tiger Global was down 40% year-to-date by the end of April, and the Nasdaq suffered its largest monthly drop since the 2008 financial crisis.

Even with—or perhaps because of—strong investor appetite in Nigeria’s tech ecosystem so far in 2022, concerns have been raised again about investment and valuations in Nigeria’s tech ecosystem. The concerns have grown louder and more specific as the bearish trend spreads across global markets. Will we see a slowdown in investment in Nigeria? Has the Tech Africa Rising bubble burst? Is it time to pay the piper?

These questions relate to the theme of how we value startups, and that is the topic we revisit today. Specifically, last time, we made a broad generalisation that I repeat here.

Two main factors determine the long-term value of a start-up (or any company):

1. The long-term size of the market (market potential).
2. The start-up’s ability to capture that market (business execution).

This article focuses on the first (and more important) factor: market potential. We will analyse Nigeria’s market potential to gauge whether recent tech investments and valuations make sense.

First, a word.

Many clever people will dispute the importance of market potential (or size). They would argue that the team, product, technology, innovation, or other factors are as important or even more critical.

I disagree.

As Marc Andreessen, the famous co-founder of a16z, argued convincingly in 2007, the market matters most.

Here is an example to illustrate this point.

Would you be interested in running a vending machine business? I imagine the number of people that answered affirmatively is in the single digits. Here is another question.

What would you estimate as the market size for vending machines in the US?

Hold that thought. Let’s share some statistics first. These are the 2021 GDP figures for different sectors in Nigeria, i.e., the annual market output or size for these industries:

• Agriculture: $88 billion
• Oil & Gas: $21 billion
• Cement: $14 billion
• Finance & Insurance: $13 billion
• Real Estate: $22 billion

Back to our question. In 2021, the US's market size for vending machines was roughly $9 billion. The market for vending machines in the US is not that far off the market for key industries like cement and finance in Nigeria. To be a billion-dollar company in Nigeria, you probably have to be in one of the largest sectors—agriculture, energy, etc. You can be a billion-dollar vending machine entrepreneur in the US.

No product, team, or innovation can compare with a market ripe for the taking.

How attractive is the Nigerian market?

If the market matters most for Nigeria’s startups, how attractive is the market?

Like many things in Nigeria today, it is easier to build a data-driven case for why the Nigerian market does not justify recent activity and valuations in the tech ecosystem. The Economist and Financial Times did so last year, albeit with minimal rigour.

Is the pessimism warranted?

A good starting point is looking at GDP per capita, the most basic summary statistic for annual income or spending power in the country. In 2021, Nigeria’s GDP per capita was $2,100, less than the likes of Cote d'Ivoire ($2,300), Sri Lanka ($3,700), and Vietnam ($2,800). Most jarringly, Nigeria’s GDP per capita is not much higher than the average of a clutch of nations the World Bank terms “Fragile & Conflict-affected situations” ($1,600).

Admittedly, GDP per capita is an imperfect metric for what we are analysing here, as we have highlighted before. Its most problematic feature is that it is simply an average (mean) of GDP across the population, so it does not show the true spread of spending power.

Income distribution statistics are notoriously difficult to find in Nigeria, even more so those that are internationally comparable. We can turn to World Bank data tracking the number of people in a country that can afford to spend more than $10 a day. This is a pretty good measure of market size for many consumer products because it directly measures spending, which is the best indicator of the existence of a market and how big it is.

How does Nigeria fare on this metric? We can look at the number of Nigerians that can spend more than $10 a day. Less than 4 million out of Nigeria’s 200 million people consume more than $10 a day. That is less than Ghana (5.2 million) and South Africa (16 million). It is also way behind comparable countries (by population) like Brazil (125 million) and Indonesia (46 million).

The picture is worse when we look at the share of Nigerians that can spend more than $10 a day. Just under 2% of Nigeria’s population can afford to spend more than $10 a day, compared to 17% in Ghana, 27% in South Africa and 60% in Brazil. In fact, Nigeria has more in common with Mali (0.5%) and Uganda (3.6%) than those other countries.

Few people have money to spend in Nigeria.

Having said all of this, we could argue that even if Nigerians don’t have spending power, credit could propel the market. Unfortunately, it is difficult to get credit in Nigeria. Going by the latest (2020) financial inclusion data from Enhancing Financial Innovation & Access (EFInA), only 2% of Nigerians had an outstanding loan from a bank, even though up to 45% of Nigerians had bank accounts. Even after accounting for informal credit channels, just over a quarter of the adult population had access to any type of credit.

Credit can only power the market if Nigerians can access it.

Then again, even if we admit that Nigerians have neither direct spending power nor the credit access needed to bridge the spending gap today, this could change in the future. Forecasts of GDP growth suggest otherwise.

The International Monetary Fund expects Nigeria’s GDP growth to average 3% between now and 2027. That would put economic growth just ahead of Nigeria’s last estimate of population growth (2.6%) so GDP per capita would remain stagnant. Even more optimistic estimates do not paint a particularly rosy picture. The Nigerian National Development Plan for 2021 to 2025 expects GDP growth to average 4.6% up till 2025—that still pales in comparison with the 6% average GDP growth Nigeria achieved in the early 2010s.

We could keep going, analysing Nigeria’s market by looking at metrics that capture income, wealth, spending power, and so on. Few of them will tell a dissenting view. Overall, the numbers don’t obviously suggest vast market potential in Nigeria. So, what gives?

So why all this investment?

There are many ways to rationalise recent activity and valuations in Nigeria’s tech ecosystem even if you agree with the pessimistic assessment of Nigeria’s consumer market presented earlier. The most compelling is the reminder that when analysing startups, we need to move from a static view of the market to a dynamic view, i.e., investors are often not just betting on how the startup will evolve but also on how the market will too.

Let’s use digital banks as an example.

Last year, Kuda Bank caused a stir when it confirmed its $55 million Series B round, which valued the company at $500 million, significantly above Tier 2 banks like FCMB and Sterling and only behind financial behemoths like Zenith Bank ($1.8 billion). In fact, Kuda’s $500 million valuation isn’t too far from Access Bank’s ($850 million), a company that attained revenues of $2.3 billion in 2021.

Kuda has roughly 1.5 million digital customers, compared to Access Bank’s 20 million, and Access Bank has tons of non-digital customers as well. In fact, Access Bank was able to open nearly as many customer accounts (1.3 million) under its agency banking initiative program as Kuda Bank has customers.

How can Kuda and Access be so far apart in every metric that matters yet be valued so closely? One reason that is important to state and move on quickly from is that they are priced in different markets—Kuda is priced in the private African tech market and Access is valued on the Nigerian Stock Exchange. This fact alone makes a huge difference but doesn’t explain all of it.

Kuda’s valuation is not just based on the company’s performance today but reflects investors’ belief about its ability to (1) steal market share from less digital-savvy incumbents (2) expand the market for financial services in Nigeria. They can do the latter in either of two ways. The first is by finding innovative ways to monetise current consumers (i.e., increase average revenue per user) while keeping costs stable. The second is by finding innovative ways to capture and monetise new users (Nigeria’s 55% financially excluded) in a profitable way.

In other words, Kuda’s valuation is a bet on what Nigeria’s future market for financial services will be and the startup’s ability to create and capture this market. Or, leaning on a Stears report on Nigerian digital banks in 2021, “Looking at the present is a needlessly narrow lens for analysing digital banks, which at their core, are disruptive, high-impact digital startups, valued as much—if not more—for their transformative potential than current realities.”

A key assumption here is the startup’s (Kuda) role in finding and unlocking this market potential (the famous product-market fit). Consider, for example, current digital bank offerings. According to the 2020 Agusto Consumer Digital Banking Satisfaction Index, 90% of Nigerians that use digital banking services do so for funds transfers, 77% for airtime or data top-ups, and 54% do so to check their account balance.

None of these are particularly profitable services for Nigerian banks. Even as they successfully migrate customers from branches to mobile phones, they are not necessarily making more money off them. Traditional banks have not figured out how to leverage digital distribution to monetise existing or new customers—they are simply replicating non-digital services and, at best, improving their margins.

Of course, digital banks like Kuda will also need to overcome this challenge, the same way their peers in Latin America have done so. In their investment note summarising Kuda’s Series B raise, Renaissance Capital echoed this sentiment, highlighting, “We think not too many African fintechs will have the luxury of playing freemium for too long and will need to quickly solve the monetisation puzzle.”

So, what exactly does this story of digital banks tell us about Nigeria’s market potential?

Founders, investors, and the entire ecosystem are not just betting on Nigerians’ disposable income, financial access, or internet penetration today; they are betting that startups are better placed to better monetise the current market and to find and monetise a larger pool of customers.

The bet is that the market is dynamic.

These ideas are not new and are well-accepted today. I give credit to the late Clayton Christensen, Efosa Ojomo, and Karen Dillon for poetically capturing the essence of this dynamic market through the idea of non-consumption.

Put simply, nonconsumption exists when someone wants to purchase and use a product for a specific product (or job) and cannot do so. Take financial services. Although only 27% of adult Nigerians have a savings account, all of them want to complete the job of saving, i.e., everyone wants to save.

Accounting for non-consumption reveals the true market potential. For a savings product, it isn’t the 27% of adult Nigerians with a savings account, but all adult Nigerians interested in transferring money from today to tomorrow (saving).

The problem with nonconsumption is that it is often hard to spot. This should not surprise us as it’s much harder to find that data you can’t see. Yet the data that lies unseen tells as much of a tale as the data that lies visible. 

This idea underlines why investors obsess over product-market fit and founder-market fit. Their investment is often a bet that this team will find the nonconsumption and this product will do the required job.

None of this is theoretical either; we have already seen it multiple times in the African market. Over the last decade, pay-as-you-go solar companies have done the impossible: making money from selling bite-sized electricity to rural Africans. Two of these companies were recently involved in a $200 million acquisition. Mobile money is another great example. M-Pesa’s revenue for the 2020/2021 financial year was over $750 million because mobile money helped millions of Africans complete a job (financial transactions) they were previously unable to do with banking services.

Sometimes, startups directly focus on creating the market through market-creating innovations. The new generation of fintech credit companies like Indicina are a case in point. They don’t provide loans to consumers; they are focused on building the information infrastructure to enable consumer lenders to profitably give loans to a larger cohort of borrowers. In essence, they are solving nonconsumption by solving the underlying information asymmetries in Africa’s credit markets.

The market is what you make it

When you build or invest in a startup, you’re placing a bet on the future of the business and market. Often enough, startups can unearth or “influence” this market.

Many debates about startup valuations in Nigeria are partly just disagreements about Nigeria’s future market potential. Although no one knows the future, I lean towards the people taking bets (investors) and those in the arena (founders). Afterall, the best way to predict the future is to build it.

Founders and investors will sometimes be incorrect in their assessment of the market potential. That is inevitable and should be seen as a feature of the system, not a bug. Moreover, even when they are correct about their market assessment, they can still be wrong about valuations. As we’ve seen often enough now, valuations depend on a myriad of factors, and not all of them are fundamentally reasonable.

We will illustrate this and end with an anecdote.

At the start of December 2017, First Bank Holding Company (FNBH) was priced at just over ₦7 per share on the Nigerian Stock Exchange. This meant that the market valued FBNH at less than 50% of its book value (assets minus liabilities), which is what the company’s shareholders would get if it were liquidated. In an ideal world, investors should never value a company at less than 100% of its book value. This “made sense” at the time because the Nigerian stock market was in shambles after foreign investors fled the central banks’ capital controls, and FBNH was in the spotlight for its high-performing loans.

Yet, going into 2018, analysts at Vetiva Capital, a Lagos-based investment bank, gave the company a target price close to ₦12, stressing that the discount the market had applied to the company was too steep.

Fast forward to the end of January 2018 and the brief return of foreign investment into the market, and FBNH’s share price had risen above ₦13. Within two months, Nigeria’s oldest bank had gone from ₦7 per share and undervalued to ₦13 and the hottest company on the stock exchange. All because foreign investors returned to the market.

The lesson? Short-term valuations are bullshit. Even if Nigeria’s tech ecosystem feels the heat of the global investment slump, the market remains dynamic and full of promise.